USPS-T-6

BEFORE THE

POSTAL RATE COMMISSION

WASHINGTON DC 20268-0001

  ------------------------------------- ---------------------------------
  [POSTAL RATE AND FEE CHANGES,         Docket No. R2001--1
  2001]{.smallcaps}                     

  ------------------------------------- ---------------------------------

DIRECT TESTIMONY OF

WILLIAM P. TAYMAN, JR.

ON BEHALF OF

UNITED STATES POSTAL SERVICE

[CONTENTS]{.underline}

AUTOBIOGRAPHICAL SKETCH iv

I. PURPOSE AND SCOPE OF TESTIMONY AND GUIDE TO SUPPORTING
DOCUMENTATION.................................................. 1

II\. SUMMARY OF FINANCIAL AND OPERATING RESULTS

AND CURRENT FINANCIAL CONDITION 3

III\. TEST YEAR REVENUE REQUIREMENT 12

A. Summary of Test Year Cost Estimating

Procedures 12

1\. Base Year 12

2\. Fiscal Years 2001, 2002 and the Test Year 12

3\. Sources of Change:

a\. Cost level 13

b\. Mail volume effect 13

c\. Non-volume workload effect 13

d\. Additional workday effect 14

e\. Cost reductions 15

f\. Other programs 16

g\. Base year unit cost adjustment. 18

h\. Workyear mix adjustment 19

i\. Final adjustments 20

B. Specific Estimating Elements 21

1\. Labor contract 21

2\. Other salary and benefit changes 22

3\. General price increases 23

C. Revenue Requirement 24

1\. Accrued costs 24

a\. Postmasters (Segment 1) 25

b\. Supervisors and Technical Personnel

(Segment 2) 26

c\. Clerks and Mail Handlers CAG A

through J Offices (Segment 3) 27

d\. Clerks, CAG K Offices (Segment 4) 28

e\. City Delivery Carriers (Segments 6 and 7) 29

f\. Vehicle Service Drivers (Segment 8) 30

g\. Rural Carriers (Segment 10) 31

h\. Custodial and Maintenance Services

(Segment 11) 32

i\. Motor Vehicle Service (Segment 12) 32

j\. Miscellaneous Local Operations

(Segment 13) 33

k\. Contractual Transportation of Mail (Segment 14) 35

l\. Building Occupancy (Segment 15) 36

m\. Supplies and Services (Segment 16) 37

n\. Research and Development (Segment 17) 38

o\. HQ & Area Administration & Corporatewide

Personnel Costs (Segment 18) 39

p\. Equipment Maintenance & Management

Training Support (Segment 19) 43

q\. Depreciation, Write-offs, Claims, & Interest

(Segment 20) 44

2.  Provision for Contingencies & for Recovery of Prior Years'
    Losses.....................................................................
    46

a\. Framework for Contingency 47

b.  Institutional Factors Demonstrate the Need for the

> Proposed Contingency 50

c.  The Contingency Provides Protection Against Real

Risks 52

d.  There Continue to Be Significant Economic Risks 53

e.  Postal Service Assets Do Not Protect Against Financial

> Risk 55

f.  Debt is Not a Substitute for an Adequate Contingency Provision 56

g.  The Contingency Provision Was More than Fully

> Consumed in Docket No. R2000-1 57

h.  There is a Wide Range and Number of Significant

> Possible Adversities. 58

i.  Variance Analysis 65

j.  Recovery of Prior Years' Losses 67

IV\. REVENUES BEFORE AND AFTER RATES 71

A. Mail and Special Services Revenues 71

B. Appropriations 71

C. Interest Income 73

V. TEST YEAR REVENUE DEFICIENCY 75

EXHIBITS

LIST OF ASSOCIATED LIBRARY REFERENCES

The following library references are associated, in whole or in part,
with my testimony. Where a library reference is associated in part with
my testimony, those portions so associated are indicated.

USPS-LR-J-49 Explanation of Cost Reductions and Other Programs

> (sections 2--4)

USPS‑LR‑J‑50 Rollforward Expense Factors

USPS‑LR‑J‑51 Workers' Compensation Expense

Direct Testimony

of

William P. Tayman, Jr.

AUTOBIOGRAPHICAL SKETCH

My name is William P. Tayman, Jr. and I am the Manager, Budget &
Financial Analysis for the United States Postal Service. I was appointed
to this position in September 1995 and my primary responsibilities
include the development and administration of national operating
budgets.

Prior to this appointment, I was Manager, Strategic & International
Finance and Manager, Revenue, Volume and Cost Analysis. I began my
career with the Postal Service in 1975. From 1975 through 1978, I held
positions at the Postal Service Training & Development Institute and in
the Accounting Division at Postal Headquarters. During the period from
1978 through 1980 I was employed by the Pension Benefit Guaranty
Corporation (PBGC). At PBGC, I held the position of Deputy Controller.

In 1980, I returned to the Postal Service Headquarters as General
Manager and then Office Director of Accounting. In this position, I
served as chief accountant of the Postal Service. In 1991, I was
selected to attend the Sloan Fellows Program at Stanford University
where I received a Master's Degree in Management. I also received a
Bachelor Degree in Business and Public Administration from the
University of Maryland in 1972. After graduation from the University of
Maryland, I was employed at Hoye, Graves, Bailey & Co., a regional
Certified Public Accounting firm.

I am a licensed Certified Public Accountant in the State of Maryland. I
also am a member of the American Institute of Certified Public
Accountants and the Maryland Association of Certified Public
Accountants. In Docket Nos. R87-1 and R90-1, I sponsored testimony
concerning the estimation of workers' compensation and retirement costs.
In Docket Nos. R97-1 and R2000-1 I sponsored the Postal Service's
revenue requirement testimony.

I.  PURPOSE AND SCOPE OF TESTIMONY AND GUIDE TO SUPPORTING DOCUMENTATION

My testimony presents the Postal Service\'s revenue requirement for the
Test Year (TY)[^1]. This testimony was prepared in conformance with the
Commission\'s Rules of Practice and Procedure to support the Postal
Service\'s revenue requirement for the Test Year. The attached exhibits
and the material included in Library References J-49, J-50, and J-51
supplement my testimony.

Exhibits A through T are at the end of my testimony and are preceded by
an index of Exhibits. These exhibits provide summary components of the
revenue requirement. Library Reference J-49, "Explanation of Cost
Reductions and Other Programs," supplies the narrative descriptions and
fundamental estimating elements of the cost reduction program savings
and other programs expense built into the revenue requirement. I am
sponsoring sections 2--4 of Library Reference J-49. Library Reference
J-50, "Rollforward Expense Factors," supplies the detailed calculations
underlying the revenue requirement. Library Reference J-51, "Workers'
Compensation Expense," supports the projection of Workers' Compensation
liability and expense.

My testimony is organized into five chapters as described below.

Chapter I explains the purpose of my testimony. Chapter II, entitled
\"Summary of Financial and Operating Results and Current Financial
Condition,\" describes (1) financial and operating results over the last
ten years, and (2) the current financial condition of the Postal
Service. This chapter reflects the developing deterioration in the
Postal Service's financial position. The material presented supports a
proposed level of rate increases consistent with management\'s goals of
repairing the Postal Service's

financial position, recovering prior years' losses, reducing debt,
supporting the Postal Service's capital program, and restoring equity.

Chapter III, entitled \"Test Year Revenue Requirement,\" (1) describes
the specific sources of the changes in Postal Service costs which are
included in the revenue requirement, (2) identifies the assumptions used
to project cost increases, and (3) defines the change in the revenue
requirement by cost segment. This chapter also presents management's
rationale for selecting the provisions for contingencies and recovery of
prior years\' losses; these support the financial integrity and
stability of the Postal Service. Considerable additional discussion and
analysis has been added to the section on the contingency provision.
This chapter also incorporates the Postal Service's testimony on
Workers' Compensation expense.

Chapter IV, entitled \"Revenues Before and After Rates,\" describes the
level of revenue anticipated during the Test Year on a before-rates and
after-rates basis. This chapter unifies the analyses of our revenue
estimates by combining a discussion of the revenue anticipated from mail
and special services with a discussion of anticipated revenues from
appropriations and investment income.

In Chapter V, entitled \"Test Year Revenue Deficiency,\" I calculate the
overall revenue deficiency and analyze the effect of the proposed rates
on that deficiency.

II. SUMMARY OF FINANCIAL AND OPERATING RESULTS AND CURRENT FINANCIAL
    CONDITION

In this chapter, I discuss financial results and the financial condition
of the Postal Service over the last ten years, from Fiscal Year 1991
through Fiscal Year 2001. Over this ten-year period, the Postal Service
provided both reliable service and a reasonable degree of rate
stability.

This section also includes certain projected results for the three years
underlying this case: FYs 2001, 2002 and 2003. Unless otherwise noted,
the historical data used in this analysis are drawn from the Audited
Financial Statements of the United States Postal Service for Fiscal
Years 1991 through 2000. This analysis will show that, without increased
rates in the test year, the Postal Service's already weak financial
condition will continue to deteriorate.

Thirty years' experience has demonstrated that the combined pressures of
providing universal service as an establishment of the federal
government and the increasingly competitive nature of the markets in
which the Postal Service functions make the congressionally-mandated
goal of break-even extremely difficult to achieve. Over this period
there were only two periods of sustained net incomes, one of which was
in the most recent ten-year period analyzed in this chapter. By the
beginning of Fiscal Year 1995 the Postal Service's equity had dropped to
a negative \$6.0 billion, reflecting cumulative losses of \$9.0 billion.
See Exhibit 6L. During much of the period leading into 1995, the Postal
Service dealt with unprecedented financial burdens as a result of cost
transfers in excess of \$8 billion (see Exhibit USPS-6K), resulting from
Omnibus Budget Reconciliation Acts (OBRAs). While the continuing
obligations are significant, there have been no additional cost
transfers since the Omnibus Reconciliation Act of 1993, with the
exception of transferring the requirement for funding Post Office
Department Workers' Compensation expense in FY 1997 under the Balanced
Budget Act of 1997. This absence of additional obligations to the
Federal Government, coupled with the benefits of the 1992 restructuring
and debt refinancing, extremely moderate increases in the cost of labor
and other resources, and healthy volume and revenue growth, led to a
temporary period of financial success between FY 1995 and FY 1999. We
are now seeing that period come to an end due largely to escalating
labor and energy costs and weak revenue growth.

Table 1 presents the net income (loss) and equity by year for the
ten-year historical period.

**Table 1**

Postal Service Net Income/(Loss) and Equity

(\$ Millions)

  ----------------------- ------------------------ ----------------------
  Period                  Net Income/(Loss)        Equity

  FY 1991                 (1,469)[^2]              (2,747)

  FY 1992                 (536)[^3]                (3,283)

  FY 1993                 (1,765)[^4]              (5,048)

  FY 1994                 \(914\)                  (5,961)

  FY 1995                 1,770                    (4,191)

  FY 1996                 1,567                    (2,624)

  FY 1997                 1,264                    (1,360)

  FY 1998                 550                      \(810\)

  FY 1999                 363                      \(447\)

  FY 2000                 \(199\)                  \(646\)

  Cumulative Net Income   631                      
  ----------------------- ------------------------ ----------------------

Losses occurred in five of the ten years. The first net income was
achieved in FY 1995. Subsequent net incomes dropped consistently,
falling from a high of \$1.770 billion down to \$363 million in FY 1999.
A \$199 million net loss was incurred in FY 2000. This unfavorable trend
is worsening in FY 2001. Despite the fact that this ten-year period
includes a five-year string of net incomes and the three highest net
incomes ever earned by the Postal Service, a cumulative net income of
only \$631 million (an average of \$63 million per year or approximately
0.1 percent of total revenue) was earned. This means the Postal Service
was unable to make significant progress against its prior years' losses
recovery objective during the last decade. The \$631 million of
recovered equity over this period has not restored the Postal Service's
financial strength. Moreover, the projected FY 2001 net loss will
significantly exceed this recovered equity.

Equity is expected to further deteriorate through the test year, in the
absence of a rate increase, as shown in Table 2.

**Table 2**

Postal Service Net Loss and Equity

Including Projections

(\$ Millions)

  --------------------------- -------------------- ----------------------
  Period                      Net Loss             Equity

  FY 2001                     (1,666)              (2,312)

  FY 2002                     (1,349)              (3,661)

  Before Rates FY 2003        (2,451)              (6,112)

  Cumulative Net Loss         (5,466)              
  --------------------------- -------------------- ----------------------

Without a rate increase, the Postal Service is projected to incur a
cumulative net loss of \$5.5 billion for the three-year period, FY 2001
through FY 2003. Equity would drop to a negative \$6.1 billion, the
lowest level in Postal Service history.

Table 3 presents the year-to-year and cumulative percentage increases in
total revenue and expenses for the ten-year period ending September 30,
2000.

**Table 3**

Comparison of Annual Percent Increase in

Revenue and Expense for the Ten Years

FY 1991 - FY 2000

(\$ Millions)

  ------------------- ---------------- --------- ---------------- ---------
  Period              Revenue[^5]      \% Chg.   Expense[^6]      \% Chg.

  FY 1990             40,074                     40,948           

  FY 1991             44,202           10.3      45,671           11.5

  FY 1992             47,105           6.6       47,642           4.3

  FY 1993             47,986           1.9       49,751           4.4

  FY 1994             49,577           3.3       50,491           1.5

  FY 1995             54,509           9.9       52,739           4.5

  FY 1996             56,544           3.7       54,977           4.2

  FY 1997             58,331           3.2       57,066           3.8

  FY 1998             60,117           3.1       59,567           4.4

  FY 1999             62,755           4.4       62,392           4.7

  FY 2000             64,581           2.9       64,780           3.8

  Ten-Year Increase   24,507           61.2      23,832           58.2
  FY 2000 vs. FY 1990                                             
  ------------------- ---------------- --------- ---------------- ---------

As shown in Table 3, annual revenues have risen a total of \$24.5
billion or 61.2 percent since Fiscal Year 1990. This is marginally
greater than the \$23.8 billion or 58.2 percent increase in annual
expenses over the same period. In each year since FY 1995, expense
growth has been greater than revenue growth, resulting in a slow and
steady deterioration in the Postal Service's net income position.

Table 4 extends Table 3 into the future, using projected revenues and
expenses through FY 2003.

**Table 4**

Comparison of Annual Percent Increase in

Revenue and Expense for the Ten Years

FY 1991 - FY 2003

(\$ Millions)

  ---------------------- ------------- --------- ---------------- ---------
  Period                 Revenue[^7]   \% Chg.   Expense[^8]      \% Chg.

  FY 1990                40,074                  40,948           

  FY 1991                44,202        10.3      45,671           11.5

  FY 1992                47,105        6.6       47,642           4.3

  FY 1993                47,986        1.9       49,751           4.4

  FY 1994                49,577        3.3       50,491           1.5

  FY 1995                54,509        9.9       52,739           4.5

  FY 1996                56,544        3.7       54,977           4.2

  FY 1997                58,331        3.2       57,066           3.8

  FY 1998                60,117        3.1       59,567           4.4

  FY 1999                62,755        4.4       62,392           4.7

  FY 2000                64,581        2.9       64,781           3.8

  FY 2001                66,344        2.7       68,010           5.0

  FY 2002                68,824        3.7       70,173           3.2

  Before Rates FY 2003\* 70,583        2.6       73,034           4.1
  ---------------------- ------------- --------- ---------------- ---------

> \* Excluding contingency.

This table shows the results of Postal Service plans to manage expense
growth through the test year. The 3.2 percent expense growth projected
for FY 2002 is the second lowest such growth rate over the 13 years in
the table, as well as the second lowest such rate since Postal
Reorganization in 1971. The 4.1 percent projected expense growth for FY
2003 before rates is lower than eight of the thirteen years displayed in
the table. But on the revenue side, two of the three lowest growth rates
are the revenue growth rates in FYs 2001 and 2003 before rates.

A significant factor explaining the change in the Postal Service's net
incomes and financial outlook from the peak net income year of Fiscal
Year 1995

to the present is the change in unit labor costs. Personnel expenses
account for about three-fourths of total Postal Service expenses. This
means that personnel costs are the major driver of total Postal Service
expenses and overall financial performance. Table 5 displays the growth
in unit personnel expense from FY 1995 through FY 2001.

**Table 5**

Postal Service Net Income and Personnel Expense Growth

Including Projections

Fiscal Years 1995-2001

(\$ Millions)

+----------------+----------+---------+----------+----------+-------+
| Period         | Comp     | Workyea | Cost Per | Percent  | Net   |
|                | ensation | rs[^10] |          | Growth   | I     |
|                | and      |         | Workyear |          | ncome |
|                | Bene     |         |          | Cost/    |       |
|                | fits[^9] |         |          | Workyear | (Mill |
|                | (M       |         |          |          | ions) |
|                | illions) |         |          |          |       |
+----------------+----------+---------+----------+----------+-------+
| FY 1994        | \$39,609 | 857,590 | \$46,186 |          |       |
+----------------+----------+---------+----------+----------+-------+
| FY 1995        | 41,931   | 870,160 | 48,188   | 4.3%     | \$    |
|                |          |         |          |          | 1,770 |
+----------------+----------+---------+----------+----------+-------+
| FY 1996        | 42,676   | 887,546 | 48,083   | -0.2%    | 1,567 |
+----------------+----------+---------+----------+----------+-------+
| FY 1997        | 43,835   | 898,384 | 48,793   | 1.5%     | 1,264 |
+----------------+----------+---------+----------+----------+-------+
| FY 1998        | 45,596   | 909,578 | 50,129   | 2.7%     | 550   |
+----------------+----------+---------+----------+----------+-------+
| FY 1999        | 47,333   | 919,214 | 51,493   | 2.7%     | 363   |
+----------------+----------+---------+----------+----------+-------+
| FY 2000        | 49,532   | 917,223 | 54,002   | 4.9%     | \(    |
|                |          |         |          |          | 199\) |
+----------------+----------+---------+----------+----------+-------+
| Projected FY   | 51,499   | 900,324 | 57,201   | 5.9%     | (1    |
| 2001           |          |         |          |          | ,666) |
+----------------+----------+---------+----------+----------+-------+

Increases in unit personnel costs were very moderate from 1996 through
1999, including a decrease in FY 1996. These favorable expense growth
rates enabled the Postal Service to achieve positive net incomes from
1996 through 1999. The steeper 4.3 percent unit personnel cost increase
that occurred in FY 1995, was more than compensated for by the 10
percent rate increase that went into effect on January 1, 1995.

The growth in unit personnel cost over the last two years has
accelerated to a cumulative 11.1 percent. This is close to double the
6.0 percent rate increase from the R2000-1 rate proceeding that was
implemented in two steps (January 11 and July 1) during FY 2001. Because
the last rate increase was so much less than the increase in personnel
costs, and because revenue growth has stalled, the Postal Service's
financial condition is deteriorating. This deterioration is reflected in
the Postal Service's negative equity position and the need to borrow for
operating purposes in FY 2000, the first such borrowing since 1976.

Table 6 displays the Postal Service's outstanding debt from 1972 through
the test year.

**Table 6**

Outstanding Debt

Debt as a Percentage of Statutory Ceiling

FY 1972 - FY 2003

(\$ Millions)

+----------------------+-------------+-----------+--------------------+
| Period               | Total Debt  | Debt      | Percent            |
|                      |             | Limit     |                    |
|                      |             |           | Of Statutory Limit |
+----------------------+-------------+-----------+--------------------+
| FY 1972              | 250.0       | 10,000    | 2.5%               |
+----------------------+-------------+-----------+--------------------+
| FY 1973              | 250.0       | 10,000    | 2.5%               |
+----------------------+-------------+-----------+--------------------+
| FY 1974              | 750.0       | 10,000    | 7.5%               |
+----------------------+-------------+-----------+--------------------+
| FY 1975              | 1,750.0     | 10,000    | 17.5%              |
+----------------------+-------------+-----------+--------------------+
| T.Q.                 | 2,998.0     | 10,000    | 30.0%              |
+----------------------+-------------+-----------+--------------------+
| FY 1977              | 3,498.0     | 10,000    | 35.0%              |
+----------------------+-------------+-----------+--------------------+
| FY 1977              | 2,431.0     | 10,000    | 24.3%              |
+----------------------+-------------+-----------+--------------------+
| FY 1978              | 2,364.0     | 10,000    | 23.7%              |
+----------------------+-------------+-----------+--------------------+
| FY 1979              | 1,837.0     | 10,000    | 18.4%              |
+----------------------+-------------+-----------+--------------------+
| FY 1980              | 1,770.0     | 10,000    | 17.7%              |
+----------------------+-------------+-----------+--------------------+
| FY 1981              | 1,538.0     | 10,000    | 15.4%              |
+----------------------+-------------+-----------+--------------------+
| FY 1982              | 1,471.0     | 10,000    | 14.7%              |
+----------------------+-------------+-----------+--------------------+
| FY 1983              | 1,404.0     | 10,000    | 14.0%              |
+----------------------+-------------+-----------+--------------------+
| FY 1984              | 1,337.0     | 10,000    | 13.4%              |
+----------------------+-------------+-----------+--------------------+
| FY 1985              | 1,940.0     | 10,000    | 19.4%              |
+----------------------+-------------+-----------+--------------------+
| FY 1986              | 3,104.2     | 10,000    | 31.0%              |
+----------------------+-------------+-----------+--------------------+
| FY 1987              | 4,603.4     | 10,000    | 46.0%              |
+----------------------+-------------+-----------+--------------------+
| FY 1988              | 5,842.2     | 10,000    | 58.4%              |
+----------------------+-------------+-----------+--------------------+
| FY 1989              | 6,445.0     | 10,000    | 64.5%              |
+----------------------+-------------+-----------+--------------------+
| FY 1990              | 6,947.8     | 10,000    | 69.5%              |
+----------------------+-------------+-----------+--------------------+
| FY 1991              | 8,420.9     | 12,500    | 67.4%              |
+----------------------+-------------+-----------+--------------------+
| FY 1992              | 9,903.4     | 15,000    | 66.0%              |
+----------------------+-------------+-----------+--------------------+
| FY 1993              | 9,731.5     | 15,000    | 64.9%              |
+----------------------+-------------+-----------+--------------------+
| FY 1994              | 8,973.1     | 15,000    | 59.8%              |
+----------------------+-------------+-----------+--------------------+
| FY 1995              | 7,264.7     | 15,000    | 48.4%              |
+----------------------+-------------+-----------+--------------------+
| FY 1996              | 5,906.3     | 15,000    | 39.4%              |
+----------------------+-------------+-----------+--------------------+
| FY 1997              | 5,861.4     | 15,000    | 39.1%              |
+----------------------+-------------+-----------+--------------------+
| FY 1998              | 6,413.1     | 15,000    | 42.8%              |
+----------------------+-------------+-----------+--------------------+
| FY 1999              | 6,913.1     | 15,000    | 46.1%              |
+----------------------+-------------+-----------+--------------------+
| FY 2000              | 9,313.0     | 15,000    | 62.1%              |
+----------------------+-------------+-----------+--------------------+
| FY 2001              | 11,313.0    | 15,000    | 75.4%              |
+----------------------+-------------+-----------+--------------------+
| FY 2002              | 12,913.0    | 15,000    | 86.1%              |
+----------------------+-------------+-----------+--------------------+
| FY 2003 Before       | 16,772.6    | 15,000    | 111.8%             |
| Rates\*              |             |           |                    |
+----------------------+-------------+-----------+--------------------+

> \* Includes Contingency

In absolute terms and as a percentage of the statutory debt limit, the
Postal Service's debt is steadily increasing and will be uncomfortably
close to the statutory limit in FY 2002. On a test year before rates
basis, the Postal Service could reach the statutory limit in FY 2003.
The debt trend points to the conclusion that the Postal Service is
operating at a greater risk of financial illiquidity than it has at any
other time in its financial history, except for the mid-1970's when a
billion dollar bailout from the U.S. Treasury was required to restore
the Postal Service's financial health.

Two financial indicators discussed in past revenue requirement testimony
as examples of worsening financial condition are the current ratio and
working capital. These indicators have generally deteriorated over the
last decade, indicating that the Postal Service increasingly is exposed
to financial risk.

Table 7 compares the ratio of current assets to current liabilities at
the end of each fiscal year since 1991. This comparison indicates that
the Postal Service\'s current ratio has declined substantially and
consistently from 1991 through 1996. In 1996 the ratio essentially
bottomed out and has since fluctuated around 0.1. The slight increase
shown for FY 2000 and small increases that may occur in the future are
due to the way the Postal Service is managing its cash and debt
obligations. Building a small cash reserve at year-end has helped the
Postal Service to manage its liquidity in light of the \$3 billion
annual borrowing limit. Such minor increases in the current ratio
reflect this tactic and represent the need for unusual measures to
ensure the Postal Service's liquidity. They do not signal a
strengthening of the Postal Service\'s financial position.

**Table 7**

Comparison of Current Ratios Since FY 1991

(\$ Millions)

  ------------------ ------------------ ------------------ --------------
  Period             Current Assets     Current            Ratio
                                        Liabilities        

  FY 1991            4,863              7,400              .66

  FY 1992            6,027              9,484              .64

  FY 1993            4,478              10,140             .44

  FY 1994            2,683              11,665             .23

  FY 1995            2,775              11,299             .25

  FY 1996            1,447              12,573             .12

  FY 1997            1,463              13,834             .11

  FY 1998            1,528              14,913             .10

  FY 1999            1,296              15,436             .08

  FY 2000            1,655              18,277             .09
  ------------------ ------------------ ------------------ --------------

Table 8 shows the Postal Service's debt increasing annually beginning in
FY 1998. Taken together, a declining or very low current ratio and an
increasing debt level are indicative of worsening financial condition.
The Postal Service not only continues to fund its capital program
through borrowing, but also borrowed to defray operating expenses in FY
2000. This was the first such borrowing since FY 1976. This is a
definite indicator of a worsening financial position.

**Table 8**

Change in Working Capital and Debt

(\$Millions)

+---------------------+-----------------------+-----------------------+
| Period              | Increase/(Decrease)   | Increase/(Decrease)   |
|                     | In Working Capital    |                       |
|                     |                       | In Debt               |
+---------------------+-----------------------+-----------------------+
| FY 1991             | \(640\)               | 1,473                 |
+---------------------+-----------------------+-----------------------+
| FY 1992             | \(920\)               | 1,483                 |
+---------------------+-----------------------+-----------------------+
| FY 1993             | (2,205)               | \(172\)               |
+---------------------+-----------------------+-----------------------+
| FY 1994             | (3,321)               | \(758\)               |
+---------------------+-----------------------+-----------------------+
| FY 1995             | 457                   | (1,708)               |
+---------------------+-----------------------+-----------------------+
| FY 1996             | (2,601)               | (1,358)               |
+---------------------+-----------------------+-----------------------+
| FY 1997             | (1,245)               | \(45\)                |
+---------------------+-----------------------+-----------------------+
| FY 1998             | (1,014)               | 552                   |
+---------------------+-----------------------+-----------------------+
| FY 1999             | \(755\)               | 500                   |
+---------------------+-----------------------+-----------------------+
| FY 2000             | (2,482)               | 2,400                 |
+---------------------+-----------------------+-----------------------+

The ratio of total assets to total liabilities shown in Table 9 reflects
the net income and net loss trends discussed above. After declining to a
low of .73 in Fiscal Year 1994, this ratio rose each year from FY 1995
to FY 1999 and then declined in FY 2000. Without rate increases this
ratio will drop rapidly in FYs 2001, 2002 and 2003. The growth in this
ratio was temporary and fleeting.

**Table 9**

Comparison of Total Assets to Total Liabilities[^11]

(\$ Millions)

  ----------------- ----------------- ----------------- -----------------
  Period            Total Assets      Total Liabilities Ratio

  FY 1989           15,801            16,814            .94

  FY 1990           15,943            17,880            .87

  FY 1991           18,069            21,770            .83

  FY 1992           20,885            25,231            .83

  FY 1993           20,215            26,414            .77

  FY 1994           19,169            26,364            .73

  FY 1995           19,962            25,499            .78

  FY 1996           19,659            23,768            .83

  FY 1997           21,209            24,155            .88

  FY 1998           22,699            25,215            .90

  FY 1999           24,512            26,771            .92

  FY 2000           26,100            28,717            .91
  ----------------- ----------------- ----------------- -----------------

Cost increases, fully described later in my testimony and in Library
Reference J-50, are anticipated to have a near term adverse impact on
the Postal Service\'s financial condition. These include: (1) increased
labor costs required by negotiated and arbitrated labor contracts; (2)
program costs; (3) increases in health benefits; and, (4) increases due
to general inflation in the cost of goods and services. Higher costs and
the recent shortfalls in funds from operations generally also have an
adverse impact on the amount of cash available for debt reduction, which
results in higher interest expense.

In my testimony that follows, I project the expected results for the
Test Year. The Test Year deficiency, if the proposed rates are not
implemented, will be approximately \$5.3 billion, which includes a
reasonable contingency and prior years' losses recovery. In my opinion,
the Postal Service should not allow a deficiency of this magnitude to
occur. Instead, rates must be increased to allow for repayment of debt,
restoration of equity, and strengthening of the Postal Service's
financial position. Without the proposed rate increase, the Postal
Service will find it increasingly difficult to fund expenditures
critical to the future viability of the Postal Service.

Further, without the proposed rate increase, the Postal Service cannot
meet the Board of Governors' policy on equity restoration.[^12]
Continued, high levels of borrowing would be required and would add
significantly to interest expense. Without the proposed rate increase,
the already limited capital program would have to be pared down further,
undercutting the Postal Service's ability to serve its growing delivery
network, to invest in infrastructure, and to invest in future
productivity improvements.

Operating at a loss over multiple years, further deferring equity
restoration, curtailing investments in infrastructure, and borrowing for
operations are not viable financial strategies. In light of the
increasing additional costs, which I discuss below, and my financial
projections for the Test Year, I conclude that the only prudent course
of action is to increase Postal Service revenues through a general
increase in rates.

III\. TEST YEAR REVENUE REQUIREMENT

The revenue requirement is developed by estimating changes from a Base
Year in which costs and revenues are known. There are three periods
involved in development of the revenue requirement: the Base Year
(Fiscal Year 2000), the Interim Years (Fiscal Years 2001 and 2002) and
the Test Year (Fiscal Year 2003).

A. Summary of Test Year Cost Estimating Procedures

1\. Base Year

The Base Year employed by me and by postal cost witnesses in this case
is Fiscal Year 2000. Revenues, expenses, net income and balance sheet
items developed throughout my testimony are consistent with those in the
audited and published financial statements for that year.

2\. Fiscal Years 2001, 2002 and the Test Year

Three estimated fiscal years, i.e., Fiscal Years 2001 and 2002, and the
Test Year, will be treated separately in my testimony. Cost estimating
procedures are applied to each of these years as necessary and direct
steps in the development of Test Year costs.

3\. Sources of change

Sources of change are classified as cost level, mail volume effect,
non-volume workload effect, additional workday effect, cost reductions,
other programs, workyear mix adjustments and final adjustments. These
sources of change were individually computed for purposes of explaining
total cost differences between the Base Year, Fiscal Years 2001 and
2002, and the Test Year in order to establish the basis for the revenue
requirement. My testimony explains the derivation of sources of change
factors with the exception of mail volume, and final adjustments,
including the mail mix adjustment. The rollforward witness utilizes
sources of change factors to run the rollforward model. My Exhibit 6B
contains rollforward model change reports that summarize each of the
sources of change for FY 2001, FY 2002 and the Test Year that result
from the factors developed by me and other Postal Service witnesses. The
total Test Year revenue requirement is determined by adding final
adjustments,[^13] the contingency, and the amount included to recover
prior years' losses, to the amount reflected on the after rates
rollforward model test year change report which has been adjusted for
the workyear mix.[^14]

a\. Cost level

Estimating the increase in the cost of current year resources produces
cost level changes for the subsequent year. Year-to-year price changes
primarily consist of increases in the unit cost of personnel
compensation and benefits and the cost of the previous year's level of
non-personnel resources. As detailed in my Exhibit 6Q, cost level
changes in salaries are estimated to average 5.0% in FY 2001, 3.9% in FY
2002 and 3.5% in the test year. Cost level changes in benefits are
estimated to average 7.1% in FY 2001, 6.2% in FY 2002 and 5.9% in the
test year. The derivation of cost level factors is explained in detail
in Chapters V, VI, and VII of Library Reference J-50.

b\. Mail volume effect

Mail volume effect is cost changes due to increases or decreases in mail
volume and special services volume. Cost variability due to the mail
volume effect is detailed in the testimony and workpapers of witness
Patelunas (USPS-T-12).

c\. Non-volume workload effect

These are cost changes that result from variation in measurable workload
characteristics other than mail volume. For example, city carrier street
costs vary with the number of possible deliveries. Significant
non-volume workload factors include the number of possible city
deliveries, the numbers of rural boxes and route miles, and the amount
of facilities square footage.

Additional delivery points are an important expense driver for the
postal system. Between the base year and the test year the Postal
Service will have added approximately 5 million new delivery points to
its network. This is equivalent to three cities the size of Chicago. The
Postal Service does not charge for existing or new delivery points. This
is very different from other services, such as electric, gas, water, and
local telecom, which virtually without exception have some sort of
monthly access, hookup, or system charge. Moreover, our pricing
structure is not designed to fund network growth. When mail volume
growth is less than network growth, as it is currently and is projected
to be the case through the test year after rates on a cumulative basis,
this limitation of our pricing structure places pressure on rates to
rise faster than inflationary pressures otherwise dictate. (See Exhibit
6M.)

Non-volume workload factors are summarized in Table 10. The computation
of non-volume workload factors is explained in Chapter IVd of Library
Reference J-50. The application of these factors to Postal Service costs
is explained in the testimony and workpapers of witness Patelunas
(USPS-T-12).

**Table 10**

Non-Volume Workload Factors

\% Change from Previous Year

  ------------------------------------ ----------- ----------- ------------
                                       FY 2001     FY 2002     Test Year

  No. of Post Offices [^15]            -(0.0)%     -(0.0)%     -(0.0)%

  Possible City Deliveries             0.6%        0.6%        0.7%

  Rural Route Miles                    2.2%        2.2%        2.2%

  Rural Boxes & Route Miles[^16]       2.8%        3.0%        3.0%

  Contract Stations                    3.5%        3.4%        3.3%

  Cag L Post Offices                   (2.9)%      (3.0)%      (3.1)%

  Facilities Sq. Footage (Leased)      0.7%        0.8%        0.8%

  Facilities Square Footage (Interior) 2.3%        0.8%        0.9%
  ------------------------------------ ----------- ----------- ------------

d\. Additional workday effect

Some costs vary according to the number and composition of days in each
Government Fiscal Year. For example, costs are higher on weekdays
(except holidays) than Saturdays, and lowest on Sundays and holidays.
The derivation of the additional workday factor is detailed in Chapter
IV of Library Reference J-50 and the application of these factors to
Postal Service costs is explained in the testimony and workpapers of
witness Patelunas. The number of days in each of the relevant years is
shown in Table 11.

**Table 11**

Analysis of Work Days by Fiscal Year

  ----------------------- ----------- ----------- ----------- ------------
                          FY 2000     FY 2001     FY 2002     Test Year

  Weekdays                251         250         251         251

  Saturdays               53          52          52          52

  Sundays                 52          53          52          52

  Holidays                10          10          10          10

  Workday Equivalents     295.06      293.56      294.41      294.41

  Total Days              366         365         365         365
  ----------------------- ----------- ----------- ----------- ------------

e\. Cost reductions

Numerous management-initiated cost reduction programs are currently in
progress or planned which will result in significant cost savings.
Headquarters' financial and operating managers, with the assistance of
Area, District, and Plant personnel, develop and implement plans and
monitor performance of specific projects and activities aimed at
reducing operating expenses. Much of the cost reduction savings
impacting FY 2001, FY 2002 and the Test Year derive from automation and
other equipment.

Table 12 summarizes the impact of cost reduction programs in the interim
years and the Test Year by cost segment. A summary of the major
personnel cost related cost reduction programs and the calculation of
the workyear and dollar cost savings is included in Library Reference
J-50, Chapter Vb. A listing of the major non-personnel cost related cost
reduction programs is included in Chapter Vg of Library Reference J-50.
Personnel related breakthrough productivity savings are reflected as
other programs in Chapter Vd. A narrative description of these programs
and the basis for the resource savings is contained in Library Reference
J-49.

**Table 12**

Cost Reductions

(\$ 000)

  -------------------------------------- ----------- ----------- -----------
  Segment                                FY 2001     FY 2002     Test Year

  2\. Supervisors and Technical          (47,498)    (3,222)     \-
  Personnel                                                      

  3\. Clerks and Mail Handlers, CAG A-J  (378,785)   (515,709)   (395,960)

  6&7. City Delivery Carriers            (120,130)   (4,341)     \(115\)

  11\. Custodial and Maintenance         (9,263)     (1,834)     \(438\)
  Services                                                       

  14\. Purchased Transportation of Mail  (193,000)   (166,120)   (60,147)

  15\. Building Occupancy                (40,000)    (42,000)    (40,000)

  Total                                  (788,675)   (733,226)   (496,660)
  -------------------------------------- ----------- ----------- -----------

Cost savings are projected for supervisory costs between the base year
and the test year when considered feasible by the program managers.
Supervisory cost reductions are identified for Fiscal Years 2001 and
2002 related to the consolidation of the Remote Encoding Centers. As
identified in Section f. below, large Breakthrough Productivity
Initiative (BPI) savings or Bold Actions in Cost Segment 2 are
identified in Fiscal Year 2002 (\$69.0 million) and Fiscal Year 2003
(\$50.0 million).

Between Cost Reductions Programs, BPI or Bold Actions, the Postal
Service identifies the full range of realizable cost savings for the
supervisors and technical personnel. Additional cost savings cannot be
captured predicated on theories of volume variability. Cost reduction
programs operate differently from volume changes and should not be
piggybacked. As was recognized in Docket No. R2000-1, supervisory
responsibilities relate to mailflows, networks and operations -- not
merely to employees. In addition, cost reduction programs frequently
require additional supervisory time and attention in order to capture
cost savings, to maintain service, and to ensure operating efficiencies.
Because of these issues, the Postal Service specifically examines cost
savings opportunities relating to Cost Segment 2, rather than making the
incorrect assumption that supervisor costs follow in lockstep with
programs that affect craft staffing levels.

> f\. Other Programs

This category includes changes in costs associated with
management-initiated actions other than cost reductions that change the
status quo (e.g., improve service or satisfy administrative or legal
requirements). Some programs satisfy a one-time need and are not
intended to continue indefinitely, while others will add additional
costs that continue indefinitely.

This category also includes Breakthrough Productivity Initiatives (BPI)
or Bold Actions which when added together with the cost reductions in
Table 12, sum to management's total commitment to savings between the
base year and the test year. The net savings over the three years (FYs
2001 through 2003) for Cost Reduction Programs referenced above, and the
portion of other programs that generates cost savings, are \$2.6 billion
(see LR I-49 Exhibit G).[^17]

Other programs also includes changes in expenses not directly linked to
operations, such as interest, depreciation and corporatewide personnel
costs such as annuitant costs and workers\' compensation. Other Programs
also includes the impact of accounting and reporting changes and other
miscellaneous adjustments that are not appropriate for inclusion in
other rollforward change categories. Table 13 summarizes the impact of
cost changes reflected as Other Programs for the interim years and the
Test Year by cost segment. Summaries of the major Headquarters
Administered Other Programs and the calculation of depreciation and
nationally accrued personnel related costs are included in Library
Reference J-50, Chapters IV-VI. Library Reference J-49 provides a
narrative description of each amount included under the Other Program
column and the basis for the estimated cost change.

**Table 13**

Other Programs

(\$ 000)

  ------------------------------------- ----------- ----------- -----------
  Segment                               FY 2001     FY 2002     Test Year

  2\. Supervisors and Technical         571         (66,898)    (50,000)
  Personnel                                                     

  3\. Clerks and Mail Handlers, CAG A-J (2,131)     35,928      (84,545)

  6.& 7. City Delivery Carriers         (62,895)    (94,296)    (75,866)

  10\. Rural Carriers                   \-          (18,568)    (16,579)

  11\. Custodial and Maintenance        39,226      14,365      59,685
  Services                                                      

  12\. Motor Vehicle Service            33,902      (28,154)    (25,138)

  13\. Miscellaneous Local Operations   9,935       26,599      26,000

  14\. Purchased Transportation of Mail 406,500     223,900     10,247

  15\. Building Occupancy               120,109     23,045      \-

  16\. Supplies and Services            (9,899)     139,065     (101,388)

  17\. Research and Development         2,371       1,284       1,388

  18\. Headquarters and Area Admin.     734,738     118,199     374,114

  19\. Equip. Maint. & Mgt. Tng.        \(668\)     \(12\)      \-
  Support                                                       

  20\. Depreciation, Write-offs,        304,362     246,875     414,672
  Losses, etc.                                                  

  Total[^18]                            1,576,119   621,332     532,590
  ------------------------------------- ----------- ----------- -----------

The expense growth reflected under Other Programs for FY 2001, FY 2002,
and the Test Year are \$1.6 billion, \$0.6 billion, and \$0.5 billion
respectively, or a total of \$2.7 billion. A significant amount of the
growth in FY 2001 results from non-recurring costs related to the start
up of the Fed Ex contract and bringing the Priority Mail network in
house. The remainder of the growth in each year is concentrated in
corporatewide personnel costs, depreciation and interest. Reduced
program expense reflects management's concern about the Postal Service's
financial condition as well as a continuing commitment to control costs.
There is long term risk, however, in such an approach, as it requires
deferral and cancellation of programs that would otherwise be planned to
improve the quality of service, increase responsiveness to customers,
and build and maintain our infrastructure.

g\. Base Year Unit Cost Adjustment

No adjustment to base year unit costs was necessary.

h.  Workyear Mix Adjustments

Workyear mix adjustments calculate the dollar impact of changes in the
composition of workyears assumed to occur for each individual year
between Fiscal Years 2001 and 2003. Changes in the workyear mix are
estimated to result in lower personnel costs for Fiscal Years 2001
through 2003. These amounts are relative to the personnel costs that
would have resulted if the workyear mix was assumed to remain the same
in each estimated year as it was in Fiscal Year 2000 (i.e., the amount
of personnel cost calculated by the rollforward model before this
adjustment). The net decreases calculated for Fiscal Years 2001 through
2003 before rates are \$56.7 million, \$62.1 million, and \$65.2
million, respectively. The amount calculated for the test year after
rates is a decrease of \$68.1 million.

Overtime is based on the FY 2001 operating plan. City carrier and mail
handler overtime workyear ratios are assumed to decrease in FY 2001 and
then remain at the FY 2001 ratio through the test year. The overtime
ratio reflects overtime workyears as a percentage of straight time
workyears. The clerk overtime ratio is assumed to continue at the FY
2000 level for FY 2001, as reflected in the FY 2001 operating plan, and
then remain at that level through the test year. Clerk transitional
employee (TE) workyears for FY 2001 reflect actual data through
Accounting Period 9, and are assumed to be little changed from FY 2000,
based on year-to-date FY 2001 actual paid employee experience. Clerk TE
workyears are assumed to remain at the FY 2001 level through the test
year. FY 2001 city carrier transitional employee workyears are also
based on actual data through Accounting Period 9 of FY 2001, and are
assumed to decline from the FY 2000 level based on FY 2001 actual paid
employee data. City carrier TEs are assumed to continue to decline in
FYs 2002 and 2003 at the same rate of decline experienced in FY 2001.
Casuals are assumed to continue to be utilized at the same level
experienced in FY 00 for all years through the test year.

Workyear mix adjustments decrease city carrier and mail handler costs
for FYs 2001-2003. These decreases are mainly due to the decreased
proportion of city carrier and mail handler overtime workyears in those
years relative to the proportion of overtime reflected in the base year.
The decreases in clerk costs for FYs 2001-2003 are mainly due to the
decreased proportion of career straight time workyears in those years
relative to the proportion of career straight time workyears reflected
in the base year.

The net impact of the changes due to the workyear mix is reflected as an
adjustment to the dollar estimates generated by the rollforward model
for clerks, city deliver carriers and mail handlers. The workyear mix
adjustment is explained in greater detail in Chapter VIII of Library
Reference USPS-LR-J-50.

**Table 14**

Workyear Mix Expressed As a

Percentage of Straight Time Workyears

  ---------------- ------------ ----------- ---------- ---------- ----------
                   FY 2000      FY 2001     FY 2002    Test Year  Test Year
                   Actual       Estimate    Estimate   BR Est.    AR Est.

  **Clerks A-J**                                                  

  Career-Base      91.3%        91.0%       91.0%      91.0%      90.9%

  Career-Holiday   0.7%         0.7%        0.7%       0.7%       0.7%

  Casual           5.4%         5.4%        5.4%       5.4%       5.4%

  Transitional     2.5%         2.8%        2.9%       2.9%       2.9%

  Subtotal St.     100.0%       100.0%      100.0%     100.0%     100.0%
  Time                                                            

  Overtime         8.3%         8.4%        8.4%       8.4%       8.4%

  **City                                                          
  Carriers**                                                      

  Career-Base      97.7%        97.8%       97.9%      97.9%      97.9%

  Career-Holiday   0.3%         0.3%        0.3%       0.3%       0.3%

  Casual           1.7%         1.7%        1.7%       1.7%       1.7%

  Transitional     0.2%         0.2%        0.1%       0.1%       0.1%

  Subtotal St.     100.0%       100.0%      100.0%     100.0%     100.0%
  Time                                                            

  Overtime         12.2%        10.6%       10.6%      10.6%      10.6%

  **Mail                                                          
  Handlers**                                                      

  Career-Base      88.4%        88.4%       88.4%      88.4%      88.4%

  Career-Holiday   1.3%         1.3%        1.3%       1.3%       1.3%

  Casual           10.3%        10.3%       10.3%      10.3%      10.3%

  Transitional     N/A          N/A         N/A        N/A        N/A

  Subtotal St.     100.0%       100.0%      100.0%     100.0%     100.0%
  Time                                                            

  Overtime         12.1%        11.2%       11.2%      11.260%    11.260%
  ---------------- ------------ ----------- ---------- ---------- ----------

i.  Final Adjustments

FY 2000 costs reflect the mail volume mix that existed prior to the
Docket No. R2000-1 rate changes that went into effect on January 7, 2001
and July 1, 2001. In order to reflect the cost changes due to those rate
changes and certain other volume trends at a finer level of aggregation
than represented in the Cost and Revenue Analysis (CRA) report,
adjustments were made. The derivations of these and other adjustments
are explained in the testimonies and Library References of witnesses
Eggleston, Kiefer, Nieto, and Schenk, and are summarized in the
testimony of witness Patelunas.

B. Specific Estimating Elements

In order to predict costs, known and reasonably certain cost changes are
projected. In addition, estimates based on reasonable assumptions (for
costs which will certainly change, but for which the rates of change are
not precisely known) are made. Examples of known and reasonably certain
cost changes are depreciation on existing plant and equipment, interest
expense on debt already outstanding, and the effect of the major labor
agreements now in place. Additional estimating procedures cover other
salary and benefit and non-personnel cost changes, and general price
increases.

1\. Labor Contract

The provisions of labor contracts are used to estimate wage increases
through the end of the contract periods. Most labor contracts expired in
early FY 2001. The exception is the city carrier contract, which expires
in early FY 2002. Reasonable and conservative assumptions are made
thereafter regarding the new contract provisions that will result from
labor arbitrations that are currently in process. For FY 2001, the
effective change in bargaining unit employee wages (except city
carriers), including the carryover from FY 2000, was set at the
Employment Cost Index for Wages and Salaries for Private Industry (ECI).
So that the total increase effective for FY 2001 will not exceed the ECI
calculated amount, the ECI derived amount is reduced by the FY 2001
general increase and COLA carry-over amounts from FY 2000. This is the
same method used by the Postal Service and accepted by the Commission
for the Docket R2000-1 Order No. 1294 Update. The new contract money
available under this assumption is approximately 2.0 percent.

For FY 2002 and the Test Year, an assumption is made that the total
change in wages will equal the rate of change in the Employment Cost
Index for Wages for Private Industry (ECI) less one percent. The change
in wages assumed to be effective on October 1 reflects the percentage
change in the ECI over the previous 12 months, less one percent. Since
all ECI related wage estimates effective in FY 01 and 02 are assumed to
be effective on October 1, there is no carryover into the subsequent
year. These assumptions are not meant to imply that actual labor
contract related changes in wages and benefits will be composed entirely
of general wage increases or be effective on any specific dates.

The derivation of a Test Year revenue requirement required that the
financial impact of wage changes be estimated through FY 03. The annual
and effective base wage impacts driving personnel cost level increases
are summarized in my Exhibit 6O. Additional details on the derivation of
personnel unit cost changes, which include pay increases, lump sum
payments, and cost of living allowances, can be found in Chapter VII of
Library Reference J-50. The wage and benefit costs estimated in
developing the revenue requirement are not intended to imply that these
costs are reflective of specific changes in wages and benefits which
might result from arbitration or be negotiated in the future.

2\. Other Salary and Benefit Changes

Bargaining unit employees receive periodic longevity (step) increases
that affect their average compensation. Similarly, performance-based
increases, incurred as merit increases and lump sum payouts, affect the
average compensation of non-bargaining employees. Estimated effects of
these actions are included in appropriate cost level computations and
are detailed in Chapter VII of Library Reference J-50. The step increase
amounts are offset by savings for new hires who start at the lowest step
of the salary schedule. Estimated net step amounts for selected
categories of employees are shown in Table 15 below.

**Table 15**

Step Increase Unit Costs Summary

  ----------------------------- ------------- ------------ ---------------
                                FY 2001       FY2002       Test Year

  Clerks CAG A-J, Barg.         \$81.09       \$83.65      \$121.41

  City Carriers, Barg.          \$87.96       \$90.73      \$181.07

  Mail Handlers, Barg.          \$225.82      \$232.95     \$463.81
  ----------------------------- ------------- ------------ ---------------

Federal Employee Health Benefit premiums for covered active employees
increased an average of 11.2 percent in January 2000 and 10.7 percent in
January 2001. Premium increases of 10.0 percent are expected in January
2002 and January 2003. In addition, covered employees benefited from a
change in the methodology for computing the employer share of health
benefits expense. The new weighted average formula, required under the
labor contracts, shifted about 2 percent of the insurance premium
expense from employee to employer. This change was effective in January
2000 for bargaining unit employees except rural carriers. For rural
carriers and non-bargaining employees, this shift was effective in
January 2001. Cost level computations based on these assumptions are
detailed in Chapter VII of Library Reference J-50.

3\. General Price Increases

The Postal Service is a significant purchaser of supplies for operations
and maintenance, and services such as transportation. Most cost level
changes for these items are based upon projections contained in the
DRI/WEFA[^19] USSIM/Trendlong 0501, and CISSIM/Control 0601. CPI-W
estimates from DRI/WEFA served as the basis for computation of cost of
living adjustments (COLA) for Fiscal Year 2000 and Fiscal Year 2001
under the existing labor agreements affecting bargaining unit employees.

Major indices used in this case are summarized in the Table 16.

**Table 16**

Selected DRI-WEFA Forecast Factors

(Percent Change From Previous Year)

  ----------------------- ----------- ----------- ----------- ------------
                          FY 2000     FY 2001     FY 2002     Test Year

  CPI-W[^20]              3.30        3.31        2.65        2.40

  ECI[^21]                3.22        4.12        4.16        4.25

  Supplies & materials    4.50        2.35        (1.16)      0.19
  ----------------------- ----------- ----------- ----------- ------------

A more detailed list of the indices used, along with the specific
factors for FY 2000 through the Test Year, can be found in Chapter IV
Library Reference J-50.

C. Revenue Requirement

The Test Year revenue requirement is presented in the same cost segment
format employed in the testimony of witness Patelunas. The total revenue
requirement is the sum of accrued costs for eighteen (18) cost segments,
plus workyear mix and final adjustments calculated outside the
rollforward model (see USPS Exhibit 6R), a provision for contingencies,
and an amount for recovery of prior years\' losses. Test Year revenue
requirements before and after rates are:

**Table 17**

Test Year Revenue Requirement

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Before Rates        After Rates

  Total Cost Segments             73,034,004          72,013,456

  Provision for Contingencies     2,191,020           2,160,404

  Recovery of Prior Years\'       632,809             632,809
  Losses                                              

  Total Revenue Required          75,857,833          74,806,669
  ------------------------------- ------------------- -------------------

1\. Accrued Costs

Costs for the eighteen (18) cost segments for the Base Year through the
Test Year are:

**Table 18**

Total Cost Segments[^22]

(\$ 000)

  -------------------------------- -------------------- ------------------
                                   Amount               \% Change

  FY 2000                          64,780,842           

  FY 2001                          68,010,372           5.0

  FY 2002                          70,172,627           3.2

  Test Year before rates           73,034,004           4.1

  Test Year after rates            72,013,456           2.6
  -------------------------------- -------------------- ------------------

A summary analysis of cost changes is presented here for each cost
segment. Included in the analyses are specific reasons for significant
cost increases or decreases. A brief description of the costs in each
segment is provided.

a\. Postmasters (Segment 1)

Costs of this segment for the Base Year through the Test Year are:

**Table 19**

Postmasters Cost

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         1,773,011           

  FY 2001                         1,808,958           2.0

  FY 2002                         1,890,457           4.5

  Test Year before rates          1,971,977           4.3

  Test Year after rates           1,963,492           3.9
  ------------------------------- ------------------- -------------------

Costs of the segment are the personnel costs for the following
employees:

Postmasters

District manager/postmasters of customer service districts

Some Bulk Mail Center Managers

Officers-in-Charge

Also included is the compensation and benefits for relief or replacement
of postmasters. As reflected in Table 20, Postmaster costs are mainly
impacted by cost level increases that result from estimated changes in
salaries and benefits unit costs. Costs grow more rapidly for Fiscal
Year 2002 and the test year than for Fiscal Year 2001. The cost level
effects for FY 2001 are less than in FY 2002 and 2003 because the FY
2001 pay-for-performance component is less than it was in FY 2000. This
lower level of pay for performance continues in FY 2002 and the test
year. More detailed postmaster personnel cost level assumptions and
calculations can be found in Chapter VII of Library Reference J-50.

**Table 20**

Significant Changes in Cost

Postmasters

(\$ 000)

  ------------------------------------ ----------- ----------- -----------
                                       FY 2001     FY 2002     Test Year
                                                               After Rates

  Cost Level - Personnel Costs         45,200      75,130      73,390

  Mail Volume Effect                   -1,505      2,442       162

  Additional Workday Effect            -7,410-     4,350       

  Non-volume Workload                  -338        -423        -517
  ------------------------------------ ----------- ----------- -----------

> b\. Supervisors and Technical Personnel (Segment 2)

Costs for this segment for the Base Year through the Test Year are:

**Table 21**

Supervisors and Technical Personnel Cost

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         3,664,889           

  FY 2001                         3,668,006           0.9

  FY 2002                         3,735,443           1.8

  Test Year before rates          3,849,712           3.1

  Test Year after rates           3,806,894           1.9
  ------------------------------- ------------------- -------------------

Costs of this segment include the compensation and benefits of
supervisors, professionals (non-bargaining, non-supervisory personnel),
managers of Postal installations other than post offices, and some Bulk
Mail Center managers. As reflected in Table 22, Supervisor costs are
mainly impacted by cost level increases which result from estimated
changes in salaries and benefits unit costs, cost reductions, other
programs and final adjustments. The cost level effects for FY 2001 are
less than in FY 2002 and 2003 because the FY 2001 pay-for-performance
component is less than it was in FY 2000. This lower level of pay for
performance continues in FY 2002 and the test year. Cost reductions and
final adjustments substantially offset FY 2001 cost level increases. FY
2002 and test year cost level increases are partially offset by
breakthrough productivity savings in district professional staff. Final
adjustments reflect a shift in the mail mix toward less costly
categories. More detailed supervisor and technical personnel cost level
assumptions and calculations can be found in Chapter VII of Library
Reference J-50. Additional information on segment 2 cost reductions and
other programs can be found in LR J-49.

**Table 22**

Significant Changes in Cost

Supervisors and Technical Personnel

(\$ 000)

  ------------------------------------ ----------- ----------- -----------
                                       FY 2001     FY 2002     Test Year
                                                               After Rates

  Cost Level - Personnel Costs         82,838      136,247     130,831

  Mail Volume Effect                   -6,877      2,981       -4,312

  Non-Volume Workload -- Indirect      3,129       3,326       3,459
  Effects                                                      

  Additional Workday Effect            -8,315)     4,869       

  Cost Reductions                      -47,498     -3,222      \-

  Other Programs                       571         -66,898     -50,000

  Final Adjustments                    -20,731     -9,866      
  ------------------------------------ ----------- ----------- -----------

c\. Clerks and Mail Handlers, CAG A through J Offices (Segment 3)

Costs for this segment for the Base Year through the Test Year are:

**Table 23**

Clerks and Mail Handlers, CAG A through J Offices

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         18,746,408          

  FY 2001                         19,018,490          1.5

  FY 2002                         19,215,029          1.0

  Test Year before rates          19,723,082          2.6

  Test Year after rates           19,318,672          0.5
  ------------------------------- ------------------- -------------------

Costs of this segment include the personnel costs of clerks and mail
handlers at CAG A through J offices, including Processing and
Distribution Plants and Bulk Mail Centers. As reflected in Table 24,
clerk/mail handler costs are mainly impacted by cost level increases
which result from estimated changes in salaries and benefits unit costs.
Cost level increases are substantially offset by lower workload and cost
reduction savings. Total clerk/mail handler workyears are lower in the
test year than in the base year. Cost reductions primarily relate to
automation and other equipment. For FY 01 and 02 other programs reflect
the cost of bringing the Priority Mail Processing Centers in house.
These costs are offset by breakthrough productivity savings which are
also reflected as other programs. Final adjustments reflect a shift in
the mail mix toward less costly categories. More detailed clerk/mail
handler personnel cost level assumptions and calculations can be found
in Chapter VII of Library Reference J-50. Cost reductions and other
programs are detailed in LR J-49.

**Table 24**

Significant Changes in Cost

Clerks and Mail Handlers, CAG A through J Offices

(\$ 000)

  ------------------------------------ ----------- ----------- -----------
                                       FY 2001     FY 2002     Test Year
                                                               After Rates

  Cost Level -- Personnel Costs        969,486     772,064     791,498

  Mail Volume Effect                   -74,462     -6,307      -101,968

  Non-Volume Workload Effect           704         642         624

  Additional Workday Effect            -22,508     12,945      

  Cost Reductions                      -378,787    -515,708    -395,960

  Other Programs                       -2,131      35,928      -84,545

  Workyear mix                         -20,686     -4,560      -5,816

  Final Adjustments                    -199,534    -98,465     -100,190
  ------------------------------------ ----------- ----------- -----------

d\. Clerks - CAG K Offices (Segment 4)

Costs for this segment for the Base Year through the Test Year are:

**Table 25**

Clerks, CAG K Offices Cost

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         7,075               

  FY 2001                         7,497               6.0

  FY 2002                         7,843               4.6

  Test Year before rates          8,265               5.4

  Test Year after rates           8,167               4.1
  ------------------------------- ------------------- -------------------

Costs of this segment include the personnel costs for clerks assigned to
CAG K offices. As reflected in Table 26, CAG K Clerk costs are mainly
impacted by cost level increases which result from estimated changes in
salaries and benefits unit costs.

**Table 26**

Significant Changes in Cost

Clerks, CAG K Offices

(\$ 000)

  ------------------------------------ ----------- ----------- -----------
                                       FY 2001     FY 2002     Test Year
                                                               After Rates

  Cost Level - Personnel Costs         464         373         378

  Mail Volume Effect                   -27         -36         -54

  Additional Workday Effect            -15-        9           
  ------------------------------------ ----------- ----------- -----------

e\. City Delivery Carriers (Segments 6&7)

Costs for this segment for the Base Year through the Test Year are:

**Table 27**

City Delivery Carriers Cost

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         13,139,989          

  FY 2001                         13,873,014          5.6

  FY 2002                         14,599,090          5.2

  Test Year before rates          15,324,482          5.0

  Test Year after rates           15,193,921          4.1
  ------------------------------- ------------------- -------------------

Costs of this segment include the personnel costs of city delivery
carriers. As reflected in Table 28, City Carrier costs are mainly
impacted by cost level increases, which result from estimated changes in
salaries and benefits unit costs. City carrier cost level increases are
particularly high due to the labor contract which included a step
upgrade in FY 01. However, city carrier workyears are slightly lower in
the test year after rates than in the base year, despite non-volume
workload growth in each year. This is mostly due to Delivery Bar Code
Sorter cost reductions targeted for FY 2001 and aggressive breakthrough
productivity savings reflected under other programs for FY 2002 and the
test year. Final adjustments reflect a shift in the mail mix toward less
costly categories. More detailed city carrier personnel cost level
assumptions and calculations can be found in Chapter VII of Library
Reference J-50. Cost reductions and other programs are detailed in LR
J-49.

**Table 28**

Significant Changes in Cost

City Delivery Carriers

(\$ 000)

  ------------------------------------ ----------- ----------- -----------
                                       FY 2001     FY 2002     Test Year
                                                               After Rates

  Cost Level - Personnel Costs         987,981     727,665     611,649

  Mail Volume Effect                   -12,184     36,377      43,460

  Additional Workday Effect            -38,108     22,529      \-

  Non-volume Workload Increases        45,577      49,314      52,212

  Cost Reductions                      -120,130    -4,341      -115

  Other Programs                       -62,899     -94,296     -75,866

  Workyear mix adjustment              -36,024     -834        -140

  Final Adjustments                    -31,188     -10,338     -36,369
  ------------------------------------ ----------- ----------- -----------

f\. Vehicle Service Drivers (Segment 8)

Costs for this segment for the Base Year through the Test Year are:

**Table 29**

Vehicle Service Driver Costs

(\$000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         518,562             

  FY 2001                         524,196             1.1

  FY 2002                         542,294             3.5

  Test Year before rates          570,528             5.2

  Test Year after rates           555,986             -2.5
  ------------------------------- ------------------- -------------------

Costs of this segment include the personnel costs of Vehicle Service
Drivers. As reflected in Table 30, Vehicle Service Driver costs are
mainly impacted by cost level increases that result from estimated
changes in salaries and benefits unit costs and by final adjustments.
The final adjustments reflect a shift in the mail mix toward less costly
categories. More detailed vehicle driver personnel cost level
assumptions and calculations can be found in Chapter VII of Library
Reference J-50.

**Table 30**

Significant Changes in Cost

Vehicle Service Drivers

(\$ 000)

  ------------------------------------ ----------- ----------- -----------
                                       FY 2001     FY 2002     Test Year
                                                               After Rates

  Cost Level - Personnel Costs         25,680      20,569      21,181

  Mail Volume Effect                   1,198       7,284       1,867

  Additional Workday Effect            -1,098-     642         

  Final Adjustments                    -20,146     -10,397     -9,356
  ------------------------------------ ----------- ----------- -----------

g\. Rural Carriers (Segment 10)

Costs for this segment for the Base Year through the Test Year are:

**Table 33**

Rural Carrier Costs

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         4,233,565           

  FY 2001                         4,489,870           6.1

  FY 2002                         4,744,166           5.7

  Test Year before rates          5,044,581           6.3

  Test Year after rates           5,000,870           5.4
  ------------------------------- ------------------- -------------------

Costs for this segment include the personnel costs of rural carriers and
the equipment maintenance allowance (EMA) they receive for their
vehicles. As reflected in Table 34, Rural Carrier costs are mainly
impacted by cost level increases, which result from estimated changes in
salaries and benefits unit costs and estimated changes in the CPI-U for
Private Transportation, and non-volume delivery workload growth.
Breakthrough productivity savings reflected as FY 02, and other programs
in the test year, offset some of the increases. Final adjustments
reflect a shift in the mail mix toward less costly categories. More
detailed rural carrier personnel cost level assumptions and calculations
can be found in Chapter VII of Library Reference J-50. Other programs
are detailed in LR J-49.

**Table 34**

Significant Changes in Cost

Rural Carriers

(\$ 000)

  ------------------------------------ ----------- ----------- -----------
                                       FY 2001     FY 2002     Test Year
                                                               After Rates

  Cost Level - Personnel Costs & EMA   221,478     173,454     172,866

  Mail Volume Effect                   676         24,953      30,153

  Additional Workday Effect            -13,038-    7,820       

  Non-volume Workload Effects          63,156      70,181      74,707

  Other Programs                                   -18,568     -16,579

  Final Adjustments                    -15,967     -3,544      -4,443
  ------------------------------------ ----------- ----------- -----------

h\. Custodial and Maintenance Services (Segment 11)

Costs for this segment for the Base Year through the Test Year are:

**Table 35**

Custodial and Maintenance Services Cost

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         2,560,323           

  FY 2001                         2,735,249           6.8%

  FY 2002                         2,872,066           5.0%

  Test Year before rates          3,066,237           6.8%

  Test Year after rates           3,050,324           6.2%
  ------------------------------- ------------------- -------------------

Costs of this segment include the personnel costs for custodial,
operating equipment, and building and plant equipment maintenance. Also
included are expenses for contract cleaning services. As reflected in
Table 36, the largest impact on Custodial and Maintenance costs is cost
level increases. These result from estimated changes in salaries and
benefits and the DRI index for rent. Custodial and maintenance services
costs are also affected by growth in facilities floor space (non-volume
workload), and other programs mostly related to the maintenance of
automation and other equipment which reduces costs in other cost
segments. More detailed custodial and maintenance personnel cost level
assumptions and calculations can be found in Chapter VII of Library
Reference J-50. Other programs are detailed in LR J-49.

**Table 36**

Significant Changes in Cost

Custodial and Maintenance Services

(\$ 000)

  ------------------------------------ ----------- ----------- -----------
                                       FY 2001     FY 2002     Test Year
                                                               After Rates

  Cost Level Changes                   125,191     106,853     108,845

  Mail Volume Effect                   -3,773      -1,745      -4,114

  Non-volume Workload Effects          34,097      13,126      14,345

  Additional Workday Effect            -10,329     6,113       

  Cost Reductions                      -9,263      -1,830      -438

  Other Programs                       39,226      14,365      59,686

  Final Adjustments                    -223        -65         -66
  ------------------------------------ ----------- ----------- -----------

i\. Motor Vehicle Service (Segment 12)

Costs for this segment for the Base Year through the Test Year are:

**Table 37**

Motor Vehicle Service Cost

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         772,461             

  FY 2001                         833,180             7.9

  FY 2002                         819,455             -1.6

  Test Year before rates          813,612             -0.7

  Test Year after rates           812,248             -0.2
  ------------------------------- ------------------- -------------------

Costs of this segment include the personnel costs of vehicle operating
and maintenance personnel and their supervisors, vehicle operating
supplies, and vehicle hire. As reflected in Table 38, Motor Vehicle
Service costs are mainly impacted by cost level increases and other
programs. Cost level increases result from estimated changes in salaries
and benefits unit costs, and the forecasted DRI indices for supplies and
materials and transportation services which both show smaller increases
(or decreases) in FYs 02 and 03 than in FY 01. FY 01 other programs
reflects an increase in vehicle supply cost indicated by the current
trend. FYs 02 and 03 reflect breakthrough productivity savings in
vehicle maintenance workyears. More detailed vehicle maintenance
personnel cost level assumptions and calculations can be found in
Chapter VII of Library Reference J-50. Other programs are detailed in LR
J-49.

**Table 38**

Significant Changes in Cost

Motor Vehicle Service

(\$ 000)

  -------------------------------- ------------ ------------ ------------
                                   FY 2001      FY 2002      Test Year
                                                             After Rates

  Cost Level Changes               26,395       8,766        14,239

  Mail Volume Effect               -114         595          194

  Non-volume Workload Effects      3,192        3,481        3,498

  Additional Workday Effect        -2,656-      1,587        \-

  Other Programs                   33,902       -28,154      -25,138
  -------------------------------- ------------ ------------ ------------

j\. Miscellaneous Local Operations (Segment 13)

Costs for this segment for the Base Year through the Test Year are:

**Table 39**

Miscellaneous Local Operations

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         356,582             

  FY 2001                         378,531             6.2

  FY 2002                         418,389             10.5

  Test Year before rates          457,818             9.4

  Test Year after rates           457,643             9.4
  ------------------------------- ------------------- -------------------

This segment includes the personnel costs for the Mail Equipment Shops,
and Facilities and Purchasing Service Centers. Also included are the
cost of contract stations, rental allowance for CAG L postmasters,
carfare, tolls and ferriage, field operations employee awards, and other
miscellaneous expenses. As reflected in Table 40, Miscellaneous Local
Operations are mainly impacted by cost level increases, non-volume
workload, and other programs. Cost level increases result from estimated
changes in salaries and benefits unit costs for the Mail Equipment
Shops, Facilities

Service Offices and Purchasing Service Centers, and general inflation on
contract stations, carfare, tolls and ferriage, field operations
employee awards, and other miscellaneous expenses. Non-volume workload
changes relate to the impact of changes in the number of CAG L post
offices and contract stations. Significant other program increases in
FYs 02 and the test year relate to the credit card program. More
detailed Mail Equipment Shops and Facilities and Purchasing Service
Centers personnel cost level assumptions and calculations can be found
in Chapter VII of Library Reference J-50. Other programs are detailed in
LR J-49.

**Table** 40

Significant Changes in Cost

Miscellaneous Local Operations

(\$ 000)

+--------------------------------+-----------+-----------+-----------+
|                                | FY 2001   | FY 2000   | Test Year |
|                                |           |           |           |
|                                |           |           | After     |
|                                |           |           | Rates     |
+================================+===========+===========+===========+
| Cost Level Changes             | 9,856     | 10,289    | 10,470    |
+--------------------------------+-----------+-----------+-----------+
| Mail Volume Effect             | -8        | 59        | 50        |
+--------------------------------+-----------+-----------+-----------+
| Non-volume Workload Effects    | 2,576     | 2,664     | 2,734     |
+--------------------------------+-----------+-----------+-----------+
| Additional Workday Effect      | -409-     | 247       |           |
+--------------------------------+-----------+-----------+-----------+
| Other Programs                 | 9,934     | 26,599    | 26,000    |
+--------------------------------+-----------+-----------+-----------+

k\. Contractual Transportation of Mail (Segment 14)

Costs of this segment for the Base Year through the Test Year are:

**Table 41**

Contractual Transportation of Mail

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         4,721,373           

  FY 2001                         5,091,910           7.8

  FY 2002                         5,202,851           2.2

  Test Year before rates          5,371,685           3.2

  Test Year after rates           5,132,336           -1.4
  ------------------------------- ------------------- -------------------

This segment includes the cost of non-Postal Service contractual
resources used to transport domestic mail within the United States of
America. Also included are the costs of transporting international mail
between the United States and foreign countries, and the impact of
fluctuations in international currency conversion exchange rates. As
reflected in Table 42, Contractual Transportation costs are mainly
impacted by cost level changes, mail volume workload, cost reductions,
and other programs. Cost level changes result from the level of
inflation forecasted by DRI-WEFA. The large cost level change in FY 01
is due mainly to a forecasted change in the highway transportation index
of 4.4 percent. The negative cost level change in FY 02 is mainly due to
a forecasted decline in the air transportation index of 3.3 percent.
Cost reductions include breakthrough productivity savings in all three
years, air and rail transportation trend adjustments in FY 01, and air
transportation savings in FY 02 related to the Fed Ex network. Other
programs include international and highway trend adjustments in FY 01,
Fed Ex network costs in FYs 02 and the test year, and air and highway
transportation costs related to bringing the Priority Mail Processing
Centers (PMPCs) in house in FYs 01 and 02. In Fiscal Years 01 through
the Test Year, final adjustments reflect the cost impact of mail mix
adjustments as calculated by witness Eggleston. The combination of
relatively high inflation and the cost of bringing the PMPCs in house
result in a 7.8 percent increase in costs for FY 01. The PMPC in-house
costs are offset by PMPC contract cost reductions reflected in cost
segment 16. Despite more volume related workload growth in FY 02, cost
deflation moderates total cost growth to a 2.2 percent increase. Total
transportation costs actually decline in the test year due to a decline
in volume workload, low inflation, and breakthrough productivity cost
reductions.

**Table 42**

Significant Changes in Cost

Contractual Transportation of Mail

(\$ 000)

  -------------------------------- ------------ ------------ ------------
                                   FY 2001      FY 2002      Test Year
                                                             After Rates

  Cost Level Changes               167,300      -21,440      56,930

  Mail Volume Effect               22,793       107,409      -45,705

  Additional Workday Effect        -3,457       1,941        \-

  Cost Reductions                  -193,000     -166,120     -60,147

  Other Programs                   406,500      223,900      10,247

  Final Adjustments                -29,599      -34,749      -31,840
  -------------------------------- ------------ ------------ ------------

l\. Building Occupancy (Segment 15)

Costs of this segment for the Base Year through the Test Year are:

**Table 43**

Building Occupancy Cost

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         1,555,946           

  FY 2001                         1,736,839           11.6

  FY 2002                         1,764,669           1.6

  Test Year before rates          1,766,688           0.1

  Test Year after rates           1,766,688           0.1
  ------------------------------- ------------------- -------------------

Costs of this segment include the non-capital related non-personnel
costs of occupying and maintaining Postal Service owned and rented
facilities. Such costs include rent, heating fuel, building repairs and
alterations, and utilities such as gas, electricity, water, and voice
telephone communications. As reflected in Table 44, Building Occupancy
costs are mainly impacted by cost level increases, non-volume workload,
cost reductions and other programs. Cost level increases result from
estimated changes in general inflation as forecasted by DRI-WEFA. The
fuel/oil/coal and gas indexes show double digit increases for FY 2001,
but then decrease for FY 2002 and the test year. Non-volume workload
results from changes in rented facilities floor space. In addition to
inflation, other programs are also a major cause of the large percentage
increase in FY 01. Much of the other program increase relates to the
removal of non-recurring prior year credits from the base year and
bringing the Priority Mail Processing Centers in house. Cost reductions
in all three years result from breakthrough productivity savings on
communications costs. Non-personnel related other programs and cost
reductions are explained more fully in Library Reference J-49.

**Table 44**

Significant Changes in Cost

Building Occupancy

(\$ 000)

  -------------------------------- ------------ ------------ ------------
                                   FY 2001      FY 2002      Test Year
                                                             After Rates

  Cost Level Changes               87,621       32,898       30,161

  Non-volume Workload Effects      16,821       11,840       11,858

  Additional Workday Effect        -3,657       2,046        \-

  Cost Reductions                  -40,000      -42,000      -40,000

  Other Programs                   120,108      23,046       \-
  -------------------------------- ------------ ------------ ------------

m\. Supplies and Services (Segment 16)

Costs for this segment for the Base Year through the Test Year are:

**Table 45**

Supplies and Services Cost

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         3,317,281           

  FY 2001                         3,354,292           1.1

  FY 2002                         3,466,605           3.3

  Test Year before rates          3,341,212           -3.6

  Test Year after rates           3,331,917           -3.9
  ------------------------------- ------------------- -------------------

Costs of this segment include the personnel cost of employees at the
Label Printing Units and Material Distribution Centers. Also included
are most of the supplies and contractual services utilized by the Postal
Service, including printing and reproduction and postage stock. Supplies
and services included in segments 14 and 18 are identified and are
discussed therein. As reflected in Table 46, Supplies and Services costs
are mainly impacted by cost level increases, other programs, and final
adjustments. Cost level increases result from estimated changes in
salaries and benefits unit costs for the Label Printing Units and
Material Distribution Centers and general inflation on supplies and
contractual services based on the DRI-WEFA forecast for supplies and
materials and paper and paper products. The impact of inflation on
non-personnel costs is expected to be moderate in FY 01 and the test
year, and actually decline in FY 02. Other program increases in FY 01
relate to HQ Administered Programs and Corporatewide Activities and Fed
EX start up costs. FY 01 increases are more than offset by reduced
Priority Mail Processing contract costs and a reduction in Headquarters
activity non-personnel costs which resulted from belt tightening in the
FY 01 Headquarters activity budgets. FY 01 also received a base
adjustment to remove non-recurring prior year supplies and services'
credits from the base. FY 02 reflects an increase in HQ Administered
Programs. The largest increases are for E-Business, Infrastructure, and
Information Technology. These increases are partially offset by the
non-recurrence of the FY 01 Fed Ex start up costs and the elimination of
the Priority Mail Processing contract from the base. Other programs
reflect a decline in the test year due to a reduction in Information
Technology programs. Final adjustments reflect a reduced level of
spending for Expedited mail supplies. More detailed Label Printing Units
and Material Distribution Centers personnel cost level assumptions and
calculations can be found in Chapter VII of Library Reference J-50.
Other programs impacting supplies and services are explained in greater
detail in Library Reference J-49.

**Table 46**

Significant Changes in Cost

Supplies and Services

(\$ 000)

  -------------------------------- ------------ ------------ ------------
                                   FY 2001      FY 2002      Test Year
                                                             After Rates

  Cost Level Changes               52,611       -22,488      11,267

  Mail Volume Effect               -4,935       -4,647       -7,567

  Additional Workday Effect        -767         383          

  Cost Reductions                                            

  Other Programs                   -9,898       139,065      -101,388

  Final Adjustments                                          -37,000
  -------------------------------- ------------ ------------ ------------

n\. Research and Development (Segment 17)

Costs for this segment for the Base Year through the Test Year are:

**Table 47**

Research and Development Cost

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         42,395              

  FY 2001                         44,766              5.6

  FY 2002                         46,050              2.9

  Test Year before rates          47,438              3.0

  Test Year after rates           47,438              3.0
  ------------------------------- ------------------- -------------------

Costs of this segment include contracts for new and existing technology
development and applications engineering. Personnel and related costs
and other indirect costs are included in other cost segments. As
reflected in Table 48, other programs impact Research and Development
costs. A narrative description of these programs and the basis for the
resource requirements is contained in Library Reference J-49.

Table 48

Significant Changes in Cost

Research and Development

(\$ 000)

  --------------------- -------------- ----------------- -----------------
                        FY 2001        FY 2002           Test Year After
                                                         Rates

  Other Programs        2,371          1,284             1,388
  --------------------- -------------- ----------------- -----------------

o\. HQ & Area Administration & Corporatewide Personnel Costs (Segment
18)

Costs for this segment for the Base Year through the Test Year are:

**Table 49**

HQ & Area Administration & Corporatewide Personnel Costs

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         5,377,065           

  FY 2001                         6,143,002           14.2

  FY 2002                         6,295,143           2.5

  Test Year before rates          6,706,094           6.5

  Test Year after rates           6,706,094           6.5
  ------------------------------- ------------------- -------------------

The costs of this segment include personnel costs for Headquarters and
Headquarters related field service units, the money order function, Area
Administration, and Law Enforcement. Also included are the Corporatewide
personnel-related costs of annual leave repricing, Civil Service
Retirement Unfunded Liability Principal, Workers\' Compensation,
Unemployment Compensation, Retiree Health Benefits, and CSRS Annuitant
COLA principal expense. Remaining costs are supplies and services
related to Headquarters activities and miscellaneous support costs. As
reflected in Table 50, HQ & Area Administration & Corporatewide
Personnel Costs are mainly impacted by cost level increases, and other
programs. Amounts included as other programs are mainly the year-to-year
change in Corporatewide personnel costs. With the exception of workers'
compensation costs, the derivations of Corporatewide Personnel Costs are
explained in Chapter VI of Library Reference J-50. The calculation of
Workers' Compensation expense is further explained below and in LR J-51.

Cost level increases result from estimated changes in salaries and
benefits unit costs for Headquarters and Headquarters related field
service units, the money order function, Area Administration, and Law
Enforcement. In addition, cost levels increase due to inflation on
supplies and contractual services and other miscellaneous items related
to Headquarters activities, based on the DRI-WEFA forecast for supplies
and materials and the consumer price index. FY 01 reflects a large
percentage increase due to one-time costs and transfers which occur in
FY 01. These include costs related to the termination of the Emery
transportation contract, growth in Headquarters and Field Service unit
workyears related to the transfer of the sales function from the field,
and a non-recurring credit in FY 2000 for annuity protection. Annuitant
health benefits also contribute to the large increase in FY 01 due to a
9.4 percent increase in the Postal Service share of annuitant health
benefit premiums and increases in the proportion of annuitant costs
borne by the Postal Service. Annuitant health benefits are expected to
increase by an additional 10 percent in FY 02 and the Test Year and the
cost apportionment share (related to Postal Service versus Post Office
Department service) will continue to shift towards the Postal Service.

The Postal Service is projecting an expense of \$1,189.9 million for
workers' compensation costs in the Test Year. Comparable expenses for
fiscal year 2000 were \$911.0 million. Estimated expenses for FYs 2001
and 2002 are \$949.6 million and \$1,026.2 million, respectively. These
amounts exclude all costs attributable to Post Office Department
employees injured prior to the establishment of the Postal Service on
July 1, 1971.

The Postal Service is subject to the Federal Employees' Compensation Act
(FECA). Accordingly, the Office of Workers' Compensation Programs (OWCP)
of the Department of Labor (DOL) manages the workers' compensation
program for Postal Service claimants. The Postal Service is billed
annually by the OWCP for reimbursement of all payments made to, or on
behalf of, Postal Service workers' compensation claimants over the
course of the prior OWCP "chargeback year" (July 1 through June 30).
With its reimbursement billing, the OWCP also charges the Postal Service
a pro-rata share of its estimated administrative costs.

The annual Postal Service workers' compensation expense is comprised of
three components: (1) the net present value of the total estimated
long-term liability for those claims which first become active during
the current chargeback year, (2) adjustments to the estimate of the
existing liability for claims that first became active in prior years,
and (3) the pro-rata share of OWCP administrative expenses. Adjustments
in the estimated liability result from changes in the number of active
claims, cash outlays per claim, and the estimated future duration of
claims. Separate liability estimations are made for (1) future costs
arising from payments to be provided as compensation to injured postal
claimants and their survivors ("compensation" claims) and (2) costs
arising from future medical payments on behalf of injured postal
claimants ("medical" claims).

The Postal Service and, to a lesser extent, the OWCP are continuing
ongoing efforts at cost containment. Efforts undertaken by the Postal
Service include the National Workers' Compensation Task Force, the Nurse
Coordination Program, the Duplicate Medical Bill Payment Project,
contractor review of in-patient hospital expenses, the Limited Duty Task
Force and the recent Preferred Provider Pilot with First Health.
Initiatives under development by the Postal Service include the National
Workers Reassessment Program and an Internet-based Claims Management
System. DOL/OWCP efforts include their nurse case manager program,
Periodic Roll management review teams, and quality case management
initiatives. Taken together, these efforts have served to partially
mitigate the trend towards escalation in postal workers' compensation
expense.

In reporting its financial results, the Postal Service uses the workers'
compensation estimation model to determine the year-end liability.
Changes in that liability relative to the end of the prior fiscal year
represent an expense component. In its estimations, the model uses
payment data provided on tape by the OWCP. These data are processed at
the Minneapolis Accounting Service Center to prepare summary data by
year of injury and severity of injury. These summary OWCP data,
including paid claims, average costs per claim, and a distribution of
claimant age at time of injury, are used as estimation model input.

Since Fiscal Year 1991, the Postal Service has used the "extended age"
estimation model. This model uses actual historic claimant transition
ratios, or derivations of the mathematical likelihood of claims being
paid in the next year, to estimate "surviving" claims that will be paid
in future years. These transition ratios are used to estimate surviving
claims for the first twenty-five payment years. After twenty-five years
of payment, claims are deemed to be permanent and the numbers of
subsequent surviving claims are estimated using life annuity tables in
conjunction with the claimant age at time of injury distribution. Prior
to the adoption of the "extended age" model, the Postal Service used a
model that assumed all claims became permanent after eight payment
years.

An important component of the workers' compensation liability and
expense estimation is the net discount factor used to determine the
present value of estimated future payments. Since Fiscal Year 1999, the
Postal Service used net discount factors of 1.4% for medical claims and
3.0% for compensation claims. The Postal Service periodically reviews
the discount factors. Summaries of discount rate analyses for medical
and compensation claims over the last ten years are included as Exhibit
USPS-6S, page 1 and 5. Our most recent historical and prospective
discount rate analyses for medical and compensation claims are included
as Exhibits USPS-6S, pages 2 through 4 and 6 through 8. These analyses
were based on data published in the Standard & Poor's DRI The U.S.
Economy, and its predecessor publication, DRI/McGraw-Hill's Review of
the U.S. Economy, Long-Range Focus. In the opinion of postal management,
the discount rates currently used for medical and compensation claims
represent a reasonable difference between (a) medical and societal
inflation and (b) the rates of return on government debt instruments of
terms comparable to the approximate likely lives of medical and
compensation claims. It is our opinion that the factors currently used
accurately reflect the value of the two individual liability components
and the value of the workers' compensation liability as a whole.

**Table 50**

Significant Changes in Cost

HQ & Area Administration & Corporatewide Personnel Costs

(\$ 000)

  ----------------------------------- ----------- ----------- -----------
                                      FY 2001     FY 2002     Test Year
                                                              After Rates

  Cost Level                          31,223      33,927      36,837

  Additional Workday Effect           -24         14          \-

  Other Programs (all other not       33,604      -80         -600
  itemized below)                                             

  Unemployment Compensation           22,364      2,500       2,600

  Repricing Annual Leave              -17,400     672         9,365

  CSRS Unfunded Liability --          64,082      15,517      42,941
  Principal                                                   

  Retiree Health Benefits             143,412     160,497     162,645

  Annuitant COLA -- Principal         137,402     89,495      43,163

  Workers' Compensation               38,611      76,590      163,663

  HQ & Field Service Unit Pers. Cost  72,303      -26,833     -49,663

  HQ Supplies and Services            14,397      25,514      

  Misc. Support Cost                  225,963     -225,672    \-
  ----------------------------------- ----------- ----------- -----------

> p\. Equipment Maintenance & Management Training Support (Segment 19)

Costs of this segment for the Base Year through the Test Year are:

**Table 51**

Equipment Maintenance & Management Training Support

(\$ 000)

  ---------------------------------- ---------------- -------------------
                                     Amount           \% Change

  FY 2000                            21,240           

  FY 2001                            21,191           -0.2

  FY 2002                            21,748           2.6

  Test Year before rates             22,287           2.5

  Test Year after rates              22,287           2.5
  ---------------------------------- ---------------- -------------------

Included in this segment are the personnel costs for the Maintenance
Technical Support Center and contractual services in support of
equipment maintenance and management training. As reflected in Table 52,
Equipment Maintenance & Management Training Support costs are mainly
impacted by cost level increases and other programs. Cost level
increases result from estimated changes in salaries and benefits unit
costs for the Maintenance Technical Support Center and general inflation
on contractual services based on the DRI-WEFA forecast for the consumer
price index. Other program changes relate to changes in Headquarters
Administered Programs and personnel resources at the Maintenance
Technical Support Center.

**Table 52**

Significant Changes in Cost

Equipment Maintenance & Management Training Support

(\$ 000)

+-----------------------+--------------+--------------+--------------+
|                       | FY 2001      | FY 2002      | Test Year    |
|                       |              |              |              |
|                       |              |              | After Rates  |
+-----------------------+--------------+--------------+--------------+
| Cost Level            | 619          | 569          | 539          |
+-----------------------+--------------+--------------+--------------+
| Other Programs        | -668         | -12          |              |
+-----------------------+--------------+--------------+--------------+

q\. Depreciation, Write-Offs, Claims, and Interest (Segment 20)

Costs of this segment for the Base Year through the Test Year are:

**Table 53**

Depreciation, Write-Offs, Claims, and Interest

(\$ 000)

  ------------------------------- ------------------- -------------------
                                  Amount              \% Change

  FY 2000                         3,972,677           

  FY 2001                         4,281,381           7.8

  FY 2002                         4,531,329           5.8

  Test Year before rates          4,948,306           9.2

  Test Year after rates           4,819,927           6.4
  ------------------------------- ------------------- -------------------

In addition to depreciation on equipment and buildings, this segment
includes the following costs:

Domestic and foreign mail indemnities

Insurance and tort claims

Uncollectible receivables and other write-offs

Interest expense

As reflected in Table 54, Depreciation, Write-Offs, Claims, and Interest
costs are mainly impacted by cost level increases, and other programs.
Cost level increases result from estimated changes in general inflation
on indemnities and claims and losses based on the DRI-WEFA forecast for
the consumer price index. Other programs consist mainly of estimated
changes in depreciation, interest on debt, and interest on retirement
liabilities. The before rates increase of 9.2% is higher than the after
rates increase of 6.4% due to the greater amount of borrowing that would
be required if rates are not increased. Detailed explanations of how
these costs were estimated can be found in Chapters V and VI of Library
Reference I-50.

**Table 54**

Significant Changes in Depreciation, Write-Offs, Claims, and Interest
Cost

(\$ 000)

  --------------------------------- ------------- ----------- ------------
                                    FY 2001       FY 2002     Test Year
                                                              After Rates

  Cost Level                        4,365         3,602       3,338

  Mail Volume Effect                -24           -527        2,587

  Depreciation Expense              127,723       219,219     194,331

  Disposition of Property           45,717        -46,111     -3,982

  Interest on Debt                  93,151        33,200      69,000

  Interest on Retirement            37,354        40,521      23,324
  Liabilities                                                 
  --------------------------------- ------------- ----------- ------------

2\. Provisions for Contingencies and for Recovery of Prior Years' Losses

As shown in my Exhibits and Section II of my testimony, the Postal
Service's losses are growing rapidly, equity is negative, cash flows
from operating activities are insufficient to satisfy the Postal
Service's capital needs, and debt is uncomfortably close to the Postal
Service's statutory limit. To rectify these deficiencies and safeguard
Postal Service finances from further deterioration, the Postal Service
needs a rate increase that includes the contingency provision and the
Prior Years' Losses Recovery (PYLR) provision supported in this
testimony.

The contingency operates prospectively while the PYLR provision makes up
for past shortfalls. A reasonable contingency represents a judgment of
an amount to ensure that revenues cover all costs, including those that
cannot be estimated. But when losses do occur, the PYLR provision is
necessary to restore the Postal Service's financial health. Until prior
years' losses are restored, these losses tap the limited sources of
funding available to support the Postal Service's capital program.

In response to recent unfavorable financial trends, the Postal Service
froze the facilities portion of its capital program and has frozen or
deferred other capital infrastructure projects, including delivery
vehicle acquisitions.[^23] This is a stopgap measure. It cannot
indefinitely continue. The assets that are frozen and that otherwise
would have been purchased are needed to serve our continually growing
customer base. Facilities and infrastructure are used to satisfy our
universal service obligations, and support our retail, delivery and
processing networks. Investments to improve these facilities and support
infrastructure enhance service quality and operating efficiency.

A prime illustration of the need for capital relates to the impact of
the growing delivery network. The Postal Service is obligated to serve
new delivery points whether or not volume grows commensurately and
generates revenue to fund network growth. As stated above each year the
Postal Service provides service to approximately 1.7 million new
delivery points, which is equivalent in size to the City of Chicago. At
500 deliveries per route, that translates into a need for 3,400 new
carrier routes and 4,800 new carriers. At 45 routes per facility, the
equivalent of 80 new delivery facilities are required[^24] (annexes,
stations, branches or associate offices) at an average cost of \$5
million. The resulting annual capital need for network growth is
approximately \$400 million.[^25] Due to the capital-spending freeze in
FY 2001, these types of projects have not been funded.

In its revenue requirement, the Postal Service has included a 3 percent
provision for contingencies. Postal Service management and the Board of
Governors view this as reasonable and as the minimum amount that is
necessary to address inherent uncertainties relating to the Postal
Service's projected financial status in the test year. It also better
reflects the risky financial standing of the Postal Service than the
smaller contingencies in Docket Nos. R94-1, R97-1 and R2000-1.
Recovering prior years' losses will assist in retiring debt and
restoring the Postal Service's financial health, so that the capital
program may be resumed at appropriate levels.

The Postal Service is not relying on rate increases alone to restore its
financial health. We have had extremely strong productivity performance
in FYs 2000 and 2001, and have aggressive cost savings programs in FYs
2002 and 2003, and continued limitations on capital spending. Together
with these restraints, the contingency provision and PYLR amount assist
in restoring the Postal Service's financial health. These strategies
should result in adequate funding to support operations, even in the
face of unanticipated contingencies, and are designed create the ability
to restore equity and make necessary capital investments.

a\. Framework for Contingency.

The contingency provision deals with the reality that events that affect
the Postal Service's financial picture and the impacts of those events
are, to varying and unknown degrees, unforeseen and unforeseeable.
Because history and recent events teach that there is always the
potential for the unknown and the unknowable, an adequate contingency is
absolutely essential to achieving long-run break even. An adequate
contingency provision is also a foundation for PYLR. If contingencies
are inadequate the Postal Service will fail to break even and will
therefore be unable to restore Prior Years' Losses as contemplated by
Section 3621 of the Postal Reorganization Act and Board of Governors
Resolution 95-9.

The contingency provision provides protection against possible
adversities. When adversities strike they can affect any part the postal
system. Adversities can affect revenues. Adversities can affect costs.
Adversities can relate to the quantity of mail or to the mix of mail. Or
adversities may crop up in the context of non-volume workload.
Adversities can occur with respect to the cost of resources or the
amount of resources consumed. Adversities can be specific to the Postal
Service, such as an unfavorable labor contract interest arbitration
award, or they may be more broadly based, such as political events,
natural disasters, and unexpected inflationary spikes, or sudden
economic slowdowns. For instance, the tragic events unfolding as this
testimony is finalized will undoubtedly have economic consequences, the
magnitude of which cannot be easily predicted. These events are their
repercussions are certain to create an even higher level of economic
uncertainty and fragility than existed just two weeks ago.

The contingency provision also recognizes that the Postal Service does
not control the most important factors and events relating to its
revenue and revenue needs. The Postal Service does not control its rates
and fees. It must pursue changes through this lengthy and complex
regulatory process, whose outcome ten months hence is uncertain. Due
process requirements and Postal Rate Commission rules significantly
limit the Postal Service's flexibility once the rate-making process has
begun. From the time a decision is made concerning the need for rate
increases, there is a lag time approximating 18 months to prepare and
litigate that rate filing and implement the resulting new rates. The
delay in receiving needed revenues can stretch to two years or more if
the Governors' modification authority must be exercised, as it was in
the last case. In addition, the Postal Service has no ability through
the rate making process to react rapidly to shifting market or economic
conditions.

The Postal Service does not control wage rates or terms and conditions
of employment. For non-management employees, these are subject to
negotiation and a binding arbitration process, which leads to uncertain
and sometimes surprising results.[^26] Also, federal law ties Postal
Service into various

expense programs (Federal Workers' Compensation and the Health Benefit
and Retirement systems). The Postal Service does not have the freedom to
shop for less expensive alternatives. The Postal Service's expense base
is highly exposed to inflation, particularly including the 76.7 percent
of total expenses that relates to labor and the 8.1 percent of total
expenses that relates to transportation.[^27] When adversities occur
with respect to these, the adversities go straight to the bottom line.

In considering contingency amounts, it should be understood that a small
rate increase does not make potential adversities any smaller or more
remote than does a large rate increase. To the contrary, a small
proposed rate increase may reflect aggressive productivity and cost
savings goals that translate into increased financial risk. The Postal
Service has included aggressive productivity and cost savings objectives
in this rate filing. Due to the range of possibilities a contingency is
meant to cover, it is unwise to evaluate the reasonableness of a
contingency provision by comparing it to the size of a rate increase.
The contingency provision is meant to protect the overall operation of
the Postal Service, which in the Test Year are projected to be at the
level of \$75 billion. The size of a given rate increase has no bearing
on the magnitude of possible adversities. The only possible relationship
is that a smaller increase may represent a greater risk, as noted above.

The Postal Service's 3 percent test year contingency provision implies
that the Postal Service's overall revenue and expense projections which
forecast from an FY 2000 base year to an FY 2003 test year, must be at
least 99.5 percent accurate (a 0.5 percent per year variance on average
each for revenue and expense) in order for the contingency not to be
fully consumed by adverse variances. This is a very tough standard.

b\. Institutional Factors Demonstrate the Need for the Postal Service's
Contingency Provision.

There is a range of institutional factors, which support the need for,
and the size of the Postal Service's contingency provision.

A major factor is universal service. The Postal Service has an
obligation to serve. It may not refuse to serve customers or withdraw
from geographic areas merely because they may be more expensive than
others may, or are unprofitable. The Postal Service provides delivery
service to virtually every household and every business, every day
except Sundays and Holidays. It operates some 40,000 post offices,
stations and branches.

The postal system must fund delivery-point growth whether or not we
receive contribution growth from new mail volume to support those new
delivery points. The Postal Service must serve these new delivery
points, whenever and wherever they occur. The Postal Service cannot act
to tax, channel, limit or control growth, as is frequently done by local
and municipal planning and zoning authorities if they do not wish to
provide municipal services to serve growth. The direct labor expense for
carrier-network growth (non-volume workload) between the base year and
the test year is approximately \$355 million. This is in addition to
capital requirements mentioned above.[^28]

The Postal Service also cannot unilaterally impose surcharges (such as
UPS does for different delivery types) or negotiate individual contracts
in order to ensure the profitability of each of its business segments.
The Postal Service cannot charge customers infrastructure costs to serve
new communities like utility companies. Many businesses can readily
eliminate product options, renegotiate and restructure prices, or pull
back from unprofitable customer segments in order to respond to
adversity.

The Postal Service does not withhold or reduce its basic services when
times are tough financially. We do not have permanent or rolling

delivery "blackouts", we do not close money-losing retail outlets at
will, and we do not shear off unprofitable portions of the mailstream or
refuse to serve or surcharge unprofitable customers. The entire U.S.
economy relies on the postal

network in the conduct of billions of dollars of commercial and
financial transactions every day.

Another factor relating to the contingency is that the Postal Service
carries an extremely large liability on its balance sheet. This is for
deferred retirement costs and represents financial claims that will be
made on the Postal Service. Over time, only adequate contingency
provisions ensuring the Postal Service breaks even in the face of
unexpected adversities will put the Postal Service in a position to
protect its ability to honor the obligations represented by this
liability.

The risks of not securing needed revenues in a timely manner and of
experiencing adverse revenue or cost variances are magnified by the fact
that the break-even requirement allows no margin of safety other than
through the contingency provision. Because of the zero net profit
margins that result from the Postal Service's breakeven objective, the
contingency is an especially critical tool for ensuring the long run
financial health and solvency of the postal system.

Because the contingency relates to future events that are unknown either
as to their occurrence or degree of impact, there is not always a bright
line between what is possible and what is not. Nevertheless, should a
contingency provision turn out to be greater than required to fund
operations for a period of time, there is no enrichment of executives or
employees[^29] of the Postal Service. To the contrary, the resulting net
income then serves to stabilize postal rates and hasten recovery of the
substantial accumulation of prior years' losses.

On the other hand, due to the breakeven requirement, if a contingency
provision is inadequate, it can plunge the Postal Service into a
financial and operational crisis. With \$12.9 billion in debt projected
through FY 2002 and debt at the Postal Service's statutory limit a
possibility in the test year before rates, the Postal Service is
uncomfortably close to illiquidity. In this context, it would be
ill-advised for the Commission to reduce the Postal Service's
contingency provision in recommending rates and fees.

c\. The Contingency Provision Provides Protection Against Real Risks.

In Docket No. R2000-1, the Postal Service's direct case and the rebuttal
testimonies of witnesses Strasser and Zarnowitz advised the Commission
that the Postal Service was facing substantial risks from the economy
and competition. Responding to our rebuttal witnesses, the Commission
concluded, "The short-term outlook for the national economy does not
appear to involve any significant risk of unforeseeable financial harm
to the Service." PRC Op. R2000-1, para. 2161. The Commission further
stated that there was a "comparatively low level of uncertainty
regarding potential forecast error in volume estimates for the test
year." Id., para. 2163.

Reality has been quite different from the Opinion's assessments. The
risks the Postal Service attempted to cover through its contingency
provision proved to be real. There has been a sharp, unexpected slowdown
in economic growth that placed the economy on the verge of a
recession.[^30] Also, updated demand research, which supports our volume
forecasting, shows that the Internet has made inroads into First-Class
Mail and to a lesser degree, Standard Mail volumes. Due largely to the
economic slowdown and competitive inroads, the volume and the mix of the
mail have varied to the point where it appears that test year R2000-1
revenues will

come in \$1.4 billion less than projected. This revenue variance alone
consumed the contingency recommended by the Commission in R2000-1.[^31]

The unfolding events of the last two years make it clear that the Postal
Service's string of financially successful years in the mid- and
late-1990's was atypical. In assessing the reasonableness of the
contingency provision in Docket No. R2000-1, it should not have been
assumed that success would continue unabated. Risks should not have been
assumed away. It would invite disaster to repeat that mistake in this
rate case.

d\. There Continue To Be Significant Economic Risks.

Risks relating to the economy are clear and pervasive. The Postal
Service relies in this rate filing on the macroeconomic forecasts
released by DRI-WEFA in June, 2001. The following passage comes from
that June Release,

> The risk of an economic forecast being wrong -- as soon as it is
> published -- is high under the best of circumstances. Unfortunately,
> this risk is especially high now, and the range of possible outcomes
> over the next few years is uncomfortably large.[^32]

Adverse shifts in the economy can hurt the Postal Service in at least
two ways. First, inflation can accelerate beyond projections and
negatively affect the Postal Service's costs. Second, the economy can
slow down or contract and reduce the Postal Service's revenue stream.
Both of these possibilities are encompassed in the rationale supporting
the contingency provision. At this time, the risk of slackening economic
growth is particularly high. The baseline economic forecast used in the
Postal Service's volume and Revenue projections is assigned merely a 55
percent probability by DRI-WEFA. The other DRI-WEFA scenarios -- Late
Recession (10 percent probability) and Pessimistic (35 percent
probability) -- have less economic growth through the test year. This
means the macroeconomic risks are badly skewed against the Postal
Service.

The pessimistic view is reinforced in DRI-WEFA's July release, which
asserts the "odds of a recession remain high."[^33] In the August
release DRI-WEFA reports that new "slower growth potential increases
inflation risk" and concludes,

> In the end there are not lifelines for the U.S. economy from the rest
> of the world. Whether or not the United States suffers through a
> recession or a protracted slump will depend on the efficacy of its
> monetary and fiscal policies in keeping consumer spending buoyant and
> limiting the fallout from the high-tech bust.[^34]

In terms of risks to the economy, consumer demand can weaken instead of
staying firm long enough to keep the economy out of a recession, and
business expenditures and capital expenditures can spiral downward to
further reflect declining cash flows and profits. Foreign investment in
the U.S. could weaken along with export demand. Fiscal policy changes
could backfire and reintroduce large Federal deficits and inflationary
expectations. The Fed may exhaust effective monetary policy options. Or
a new series of energy shortages or slackening productivity growth could
initiate an inflationary spiral. These are all real and substantial
risks.

As this testimony was being finalized after the Board approved filing
this rate request and the contingency provision included herein, the
terrorist attack on the World Trade Center and the Pentagon occurred.
Aside from being an enormous tragedy with grave national security
implications, it will also apparently have far-reaching and
unpredictable economic impacts. It is immediately apparent that
unemployment will grow sharply due to layoffs in the transportation and
tourism industries, and there are signs that the dollar may weaken.

In a forecast note entitled "Terror and Paralysis", DRI-WEFA's
forecasting service said on September 11th,

> The main impact of today\'s horrible events in New York and Washington
> is its human toll. It will also have an economic impact, and it is our
> job to evaluate that more measurable effect for our clients as
> promptly as possible. Accordingly, we have prepared an alternative
> forecast based on the assumption that some of the major impacts of the
> terrible events of September 11 will be on consumer confidence and the
> financial markets. Short-term, the impacts will be sharply negative as
> activity comes to a grinding halt while people try to understand and
> sort out what has happened. Consumers will be glued to their
> television sets for several days, travel plans will be canceled,
> business will be interrupted. The loss of the World Trade Center,
> which was a focus for much financial activity, will leave people
> wondering about their financial records. Tourism will plunge and
> businesses will reduce travel. In the longer term, there will be large
> expenditures for additional security, ranging from construction to
> computers to telecommunications.

In addition, depending on subsequent military and political actions,
there are new risks of oil, energy and other price hikes that could
result as subsequent events unfold. One of the sad truths that these
tragic events reinforce is that large risks can exist even in the very
short term. This proves once again that there is no natural law that
risk and uncertainties dissipate as any particular future time
approaches.

> Federal Reserve Chairman Alan Greenspan, in his first public comments
> since the attacks acknowledged yesterday on Capitol Hill that "much
> economic activity ground to a halt last week." The short-term economic
> outlook remains unclear, he said, adding that "the shock of September
> 11, by markedly raising the degree of uncertainty about the future,
> has the potential" to cause businesses and consumers to delay making
> financial commitments, such as buying new equipment, houses or
> cars.[^35]

e.  Postal Service Assets Do Not Protect Against Financial Risk.

    When examining the Postal Service's ability to withstand financial
    risk, it should be understood that the Postal Service's tangible
    assets are dedicated to the operation of the postal system and are
    not available to shore up the Postal Service's financial health when
    adversities occur. Sometimes opportunities arise to leverage these
    assets by putting them in whole or in part to higher-value
    commercial uses. These opportunities are rare, and typically are
    small in dollar amounts, but the Postal Service pursues them
    aggressively. Returns from real estate sales and development usually
    have not covered more than one- or two-tenths of a percent of the
    Postal Service's total revenue needs. The expected proceeds from
    such projects are included in the Postal Service's financial
    projections.

    From time to time, intervenors have pointed to the existence of
    these assets as reducing the need for a contingency or other
    legitimate elements of the revenue requirement. However, beyond
    their value in the operating system, these assets are not a source
    of meaningful financial security. The only real source of long-range
    financial security is equity. But this is instead a source of
    concern for the Postal Service because our equity is negative:
    estimated to be \$6.7 billion below its starting value going into
    the test year.

f.  Debt Is Not a Substitute for an Adequate Contingency Provision

When debt is used to finance operations, it is used as a stopgap that
does not compensate for inadequate revenues. Increased debt reduces the
Postal Service's ability to protect itself against financial adversity.
Increased debt increases risk.

As was mentioned above, Table 6 displays the Postal Service's
outstanding debt. In absolute terms and as a percentage of the statutory
debt limit, the Postal Service's debt is steadily increasing and will be
uncomfortably close to the statutory limit in FY 2002. This debt trend,
coupled with increasing net losses, indicates that the Postal Service is
operating at a greater risk of financial illiquidity than it has at any
other time in its financial history, with the exception of the
mid-1970's, when a billion dollar special appropriation from the U.S.
Treasury was required to keep the Postal Service solvent.

The direction of the debt trend and the level of debt support the need
for the Postal Service's contingency provision. If, in Docket No.
R2000-1, the Governors had not restored the contingency provision, and
had not reversed the other reductions in the revenue requirement made by
the Commission, the \$12.9 billion FY 2002 debt projection would have
tipped over \$14 billion, and would have placed the Postal Service less
than one payroll away from the \$15 billion aggregate debt limit.

g.  The Contingency Provision Was More than Fully Consumed in Docket No.
    R2000-1.

FY 2001 was the Test Year in the last omnibus rate proceeding. Rates
conforming to the Postal Service's proposed revenue requirement would
have had a potential FY 2001 net income of \$2 billion if the Postal
Service's 2.5 percent contingency had been maintained and none of the
contingency had been consumed. Instead, the projected FY 2001 net loss
in this rate filing is \$1.7 billion. This is a \$3.7 billion swing from
what was projected in Docket No. R2000-1. The major elements of that
\$3.7 billion swing are estimated as shown in Table 51. Of these
elements, none was predicted at the time the Postal Service filed its
request, except for the effect of delayed implementation after the
beginning of the test year.

> **Table 51**
>
> Explanation of Net Loss in FY 2001
>
> (\$ Billions)

  --------------------------------------------------------- -------------
  **Source Of Net Income/Variance**                         **Net
                                                            Income**

  Contingency @ 2.5%                                        1.7

  RPYL                                                      0.3

  **Net Income Potential**                                  2.0

  Effect of Implementation After the Test Year              (0.8)

  Initial PRC Decision                                      (0.6)

  Revenue: Economy                                          (1.4)

  Revenue: Initiatives                                      (0.2)

  Revenue: Governors' Modification                          0.2

  Inflation                                                 (0.6)

  Transportation Costs Growth                               (0.3)

  Transportation Network Changes                            (0.3)

  Workers compensation                                      (0.2)

  BPI savings                                               0.5

  **FY 2001 net loss**                                      **(1.7)**
  --------------------------------------------------------- -------------

This swing is cited not to mathematically justify the 3 percent
contingency provision in this case, but to show that recent experience
demonstrates a very real need for a substantial contingency.

h\. There Is A Wide Range and Number of Significant Possible
Adversities.

This section provides a detailed quantitative analysis of potential
adversities. Nevertheless, I would like to emphasize that the Postal
Service continues to believe that variance analysis is not an
appropriate basis for selecting a contingency provision.[^36] This
analysis does not indicate a change in our policy. The dominant
considerations in selecting a contingency provision remain management
judgment and policy with respect to the degree of risk that the Postal
Service is willing and able to absorb. This judgment should be upset if
and only if it can be shown that the proposed contingency provision, as
I have described it, is unreasonable.

This section of my testimony does not mean that the Postal Service
agrees with past criticisms or that the contingency provision should be
accepted or rejected based on any specific set of calculations. However,
due to the Postal Service's precarious financial situation, the Postal
Service cannot risk a repeat reduction of the contingency provision.

History can play a role in understanding the need for a contingency. The
detailed calculations presented here are plausible calculations based on
historical precedent. However, in reviewing these calculations it should
be understood that there are significant sources of adversity beyond the
specific calculations presented here, as indicated in section h. below.
Other sources of uncertainty can play just as great, if not a greater,
role in determining the need for a specific contingency provision.

Two calculations were performed for each source of uncertainty -- a low
estimate and a higher estimate. These two estimates do *not* form upper
and lower bounds. More extreme variations are possible and could be
justified. The lower and upper estimates simply show *one set* of
realistic possibilities based on past experience. These estimates are
plausible and illustrative rather than predictive. They show
adversities, that could occur in the test year and for which protection
needs to be afforded through a reasonable contingency provision. Only
adversities are shown because the purpose of the contingency provision
is to protect against adversity.

Sensitivity calculations are applied for two years, representing FYs
2002 and 2003. This takes into account the fact that the revenues and
costs for FY 2001 were believed to be well estimated because much of the
FY 2001 actual financial experience was available when the revenue
requirement was developed. Historical tables for each of the factors
analyzed below are given in Exhibit USPS-6T.

Fuel and Utilities Inflation

Fuel and utility prices are highly volatile and are subject to large
swings due to rapid and unexpected changes in the supply and demand
conditions in energy markets. The base year includes \$48 million in
heating fuel expense (component 166) which is driven in part by the
Fuel, Oil and Coal price index, which assumes a price decrease of 6.8
percent in FY 2002 and no change in FY 2003. It is also driven in part
by the gas index with assumed decreases of 0.8 percent and 1.3 percent
in Fiscal Years 2002 and 2003, respectively. The Fuel Oil and Coal index
rose a precipitous 45.5 percent in FY 2000. Base Year utility costs are
\$418 million (component 167) and is driven by an Electricity index. The
Electricity index grows by 1.0 and 1.1 percent in FYs 2002 and 2003,
respectively. It is plausible that these costs would grow an additional
2 to 5 percent or more per year. Based on 2 to 5 percent annual
variances, the resulting adverse test year impact ranges from \$19
million to \$48 million.

Transportation Expenses.

Transportation expenses are also subject to volatility due to changes in
the supply conditions in energy markets, but this volatility is muted
somewhat by the greater relative stability of capital and labor expenses
within this cost area. In the base year, rail transportation accounted
for \$277 million in expense, highway transportation accounted for
\$2,155 million in expense, and air transportation accounted for \$1,682
million in expense. Since 1985 the changes in the Railroad Freight Cost
index have ranged from --0.5 percent to 3.4 percent. It is projected to
grow 0.4 percent in FY 2002 and 0.3 percent in FY 2003. Since 1994 the
changes in the Interstate Trucking cost index have ranged from 2.0 to
4.4 percent, including the interim year of FY 2001. It is projected to
grow 1.8 percent in FY 2002 and repeat at 1.8 percent in FY 2003. Since
1990 the Air Freight cost index growth has ranged from --3.0 to 5.3
percent. It is projected to decline by 3.3 percent in FY 2002 and an
additional 0.1 percent in FY 2003. Should these expenses experience
additional growth of one to three percent annually, a range of adverse
expense impact from \$83 to \$251 million would result.

Wage Costs

In this case the Postal Service has estimated labor costs using existing
contracts where they exist, and ECI (Employment Cost Index) and ECI -- 1
assumptions for wages where contracts do not exist. When the ECI and ECI
-- 1 assumptions are used, there are two sources of possible variation:
the new contracts can have terms that depart from the amounts implied by
ECI and ECI -1 assumptions; and/or the actual values of ECI can vary
from what is projected in this filing. The ECI-1 assumptions are
conservative and impose risk in the sense that they assume that postal
wage settlements will increase less than labor costs in the economy as a
whole. Although, mathematically, the amounts for each type of variation
are calculated identically, these variations can compound one on top of
the other. Since 1985 the change in the Employment Cost Index has ranged
from 2.7 percent to 4.3 percent. As reflected in Exhibit 6Q, wage costs
are projected to grow 3.8 percent in FY 2002 and 3.5 percent in FY 2003.
Because there are two significant sources of uncertainty, the
possibility and amplitude of adverse results are magnified. Assuming
\$37 billion in base year wages, the total range of variation is
calculated as \$744 million to \$3,019 million (i.e., 1 percent to 4
percent annual variation).

Health Benefits.

Health benefits expense is highly volatile. The Postal Service is
contractually and legally bound to the Federal Employees Health Benefit
program and the Federal Employees Compensation Act and pays whatever
those require each year. Historically, the Postal Service's expense per
employee increased by as much as 29.6 percent in FY 1988 and dropped by
5.9 percent per employee in FY 1995. This expense item has since
re-accelerated into the double-digit growth range.

Exhibit USPS-6T includes both the ECI -- Health Benefits index and the
history of health benefits expense growth specifically relating to the
Postal Service. In 9 out of the 13 years in which economy-wide and
Postal Service-specific data are available, the inflation in health care
benefits for the Postal Service exceeded inflation for health benefits
in the economy as a whole. In 6 of those 9 years, Postal Service
inflation was more than double the inflation experienced in the private
sector. This demonstrates the enhanced degree of volatility that the
Postal Service is exposed to on this expense item.

Additional expense growth acceleration in the range of one to five
percent per year is conceivable. Calculated off of base year health
benefit costs of \$3,835 million (costs of current employees, annuitants
and OWCP health benefits) the range of adversity is from \$77 million to
\$393 million.

Volume and Revenue Projections.

Legal and regulatory issues affect volume and revenue growth rates, as
do the state of the economy, competition and changes in technology and
attitudes towards the use of the mail. Each of the approximately 100
million households and the 7 million business establishments in this
country contribute to volume and revenue growth or decline. Given the
variety and number of actors and their diverse motivations and
environments, variation between projected and actual mail volume and
revenue is inevitable. Two scenarios are considered here -- a
one-percent-per-year revenue variation from forecast and a
three-percent-per-year variation from forecast.

The revenue variance from the Docket R2000-1 estimate was more than two
percent. It should be recalled that this was close to being a
one-year-ahead forecast by the time it was updated by the Postal Rate
Commission. From the base year revenue of \$64,581 million, a
one-percent-per-year variation equates to a revenue variance of \$1,298
million. A three- percent-per-year variation results in a revenue
variance of \$3,933 million. Using the rule of thumb that approximately
half these revenue variances would be offset by lower volume variable
costs, the impacts on net income are \$649 million and \$1,966 million.
Volume mix changes (such as those which occurred with respect to the
forecasts in Docket No. R2000-1) can result in net income impacts would
be substantially more severe for a given revenue variance.

Total Factor Productivity

Total Factor Productivity (TFP) measures the growth or decline in the
Postal Service's productivity from year to year. It weighs all the
Postal Service's outputs and divides the resulting total output measure
by a weighted total input measure. TFP experienced its largest increase
in FY 1993, reflecting the impacts of buyouts and early retirement
incentives, which decreased staffing more than planned. TFP experienced
its steepest decline -- 1.9 percent -- in FY 1995.

The Postal Service is moving forward with strong productivity increases
of 2.5 percent in FY 2000, and through accounting period 12 of FY 2001 a
growth rate of 2.0 percent. In light of these most recent productivity
increases, there are concerns that there may be a natural wall being
approached which will make it difficult to sustain new productivity
gains. The Postal Service's experience has been that strong productivity
gains are frequently followed by losses or by very sluggish productivity
growth. The Postal Service's net loss of \$1.349 billion in FY 2002
assumes an additional productivity gain of 1.1 percent. The test year
after rates assumption also projects productivity gains. It seems
reasonable that actual productivity results could range from 0.5 to at
least 1.0 percentage points lower than assumed. Based on total base year
costs (revenues could be used as well) of \$64.781 billion, this
translates into a range of adversity between \$649 million and \$1,302
million.

Wholesale Price Index

The Wholesale Price Index (WPI) applies to several cost components:
Communications (Component 168), Building Projects expensed (Component
169) and Reimbursements (Component 171). The related base year cost is
\$364 million. Since 1985 annual WPI increases have ranged from a low of
--2.1 percent to a high of 5.2 percent. The projected WPI increases 0.7
percent in FY 2002 and increases by 0.8 percent in FY 2003. It is not
difficult to imagine a scenario where actual WPI inflation is one to two
percent higher than forecast. This translates into an expense impact of
\$7 million to \$15 million.

Consumer Price Index

The Consumer Price Index (CPI) is applied to a number of cost components
in the Postal Service's base year. These included individual awards
(Component 115), banking fees (Component 125), administrative and area
individual awards (Component 1429), Inspection Service Expenses
(Component 212), Reimbursements (Component 213), Commission on Money
Orders (Component 244), Contract Training Support (Component 220),
Domestic Indemnities (Component 239), International Indemnities
(Component 240), and Claims & Losses (Component 242). These expenses sum
to \$288 million in the base year. Since 1985, CPI inflation has ranged
from as low as 1.4 percent to as high as 4.9 percent. The FY 2002 and FY
2003 projections, respectively, are for 2.7 and 2.4 percent. It seems
plausible that actual CPI increases could be one to two percent higher.
This translates into a potential expense impact of \$6 million to \$12
million. Because there are no labor contracts with COLA clauses known to
be in effect through FY 2002 and into the test year, wages are not
analyzed with respect to possible variation in projected CPI.

Supplies and Material Index

The Supplies and Materials Price Index (SMPI) applies to a number of
cost components including vehicle supplies and materials (Component 99),
Components 174 through 177 in Cost Segment 16 (Supplies & Services),
operating equipment and supplies (Component 184), reimbursements
(Component 189) and supplies and services (Component 210). These sum to
\$2,795 million in the base year. Since 1985 the SMPI index has
increased as much as 5.5 percent and has declined a maximum of 2.6
percent. The FY 2002 and FY 2003 projections are for an SMPI decrease of
1.2 percent and an increase of 0.2 percent, respectively. It is quite
possible that actual SMPI inflation could be one to two percent higher
annually. This translates into a potential expense impact of \$56
million to \$113 million.

Rent Index

The Rent Price Index (RPI) is applied to Contract Cleaners (Component
81), Contract Stations (Component 111), Rent Allowances and Rents
(Components 112 and 165). The base year expense for these components is
\$855 million. Since 1985 the largest increase in RPI was 6.2 percent
and the smallest increase was 2.4 percent. The projections for FY 2002's
and 2003 are 3.3 percent and 2.6 percent, respectively. One to two
percent additional expense growths per year could possibly occur, which
translates into additional expenses of \$17 to \$35 million.

Other Factors

There are other factors not identified above which can have a
substantial bearing on the Postal Service's financial performance. These
include but are not limited to legislative or political actions or
natural disasters that impose new costs on the Postal Service or reduce
revenues. Also, Workers' Compensation expense has sometimes fluctuated
dramatically and exceeded expectations. The Postal Service has also
sometimes been overly aggressive in its expectations of new revenues
from new products or marketing initiatives, including most recently in
Docket No. R2000-1. And there may be sources of variation never before
experienced or conceived of.

The sum total of the quantified estimates in sections 1. through 10.
above are summarized in Table 52.

**Table 52**

Sensitivity Analysis

Selected Items

(\$ Millions)

  ---------------------------------- ---------------- -------------------
  Contingency Factor                 Lower            Higher

  Fuel and Utilities Inflation       \$ 19            \$ 48

  Transportation Expenses            83               251

  Wages and Salaries                 744              3,019

  Health Care Benefits               77               393

  Volume and Revenue Projections     649              1,966

  Total Factor Productivity          649              1,302

  Wholesale Price Index              7                15

  Consumer Price Index               6                12

  Supplies and Material Index        56               113

  Rent Index                         17               35

  Total                              \$2,307          \$7,154
  ---------------------------------- ---------------- -------------------

The sum total of quantified possible variances identify above is from
\$2,307 million to \$7,152 million. This range encompasses the
reasonable three percent contingency used by the Postal Service in this
rate filing.

Conclusion

The 3 percent contingency provision is reasoned and reasonable. The
Postal Service's financial situation is worsening and its ability to
absorb additional financial risk has all but disappeared. The Postal
Service is operating close to the brink. Because the Postal Service
lacks control over important revenue and expense drivers and due to the
inherent uncertainty of the future, there are significant financial
risks that create a need for a substantial contingency provision. We
urge the Commission to recognize the risks and recommend rates and fees
that include the Postal Service's 3 percent contingency provision.

i\. Variance analysis

In deference to the Commission\'s desire to evaluate forecast errors and
their sources, I have continued to include historical variance analyses
similar to those included in past filings. Pages 4 through 7 of my
Exhibit 9J reflect the results of applying the four sets of historical
weighted average cost and revenue variances calculated on pages 1
through 3 of USPS EXHIBIT 9J, to  Docket No. R2001-1 Test Year after
rates cost and revenue estimates. These produce hypothetical Test Year
variances ranging from 2.2 percent, or \$1.6 billion to 5.7 percent, or
\$4.1 billion. 

I believe historical variance analyses should not be the primary basis
for determining the need for a contingency or its size. In this case
variance analysis could be used to justify an even larger contingency
than 3.0 percent. The application of the cost and revenue variances from
the test year in the last rate case to the test year revenue and cost
estimates in this case results in an unfavorable variance of 5.7
percent. I maintain that such a simplistic and mechanistic approach to
determining the contingency is inappropriate. No matter what results an
historical variance analysis produces, it is not appropriate to use
historical data to determine the size of the contingency in lieu
of management\'s judgment about the future and the ability of the Postal
Service to assume financial risk.

These calculations are included for informational purposes only. To
conclude from any historical variance analysis that a certain level
of unforeseen events will occur in the Test Year would be
both irresponsible and illogical. No one can predict the future, but the
historical record clearly suggests that management\'s past judgment
regarding the size of the contingency required has been good.

I am convinced that variance analysis cannot be relied upon in a vacuum
as the basis for determining an appropriate contingency level.  Variance
analysis can only show us what happened in the past, and should not be
relied upon exclusively to determine the prudent amount of
cushion against unforeseen events in the Test Year. Regardless of what
history shows, management must be allowed to assume its responsibility
to determine the amount of contingency most appropriate for achieving
its goals.

It is also important to realize that the variance analyses reflected in
pages 4 through 7 of my Exhibit 6J attempt to show hypothetically how
future costs and revenues would behave if the individual segment
variances experienced in the past were to be precisely repeated in the

Test Year.[^37]  Since this does not allow for management\'s
judgment regarding the future and the influence of management\'s
subsequent actions, these types of analyses can only serve as
information to be considered by management in setting Postal Service
policy. In consideration of the Postal Service's goals and the risks
involved, a contingency of three percent has been used for the purpose
of estimating this revenue requirement.

j\. Recovery of Prior Years\' Losses

When the contingency has been inadequate or events otherwise result in
net financial losses for the postal system, the Postal Service
accumulates prior years' losses. At this point, prior years' losses have
entirely consumed the Postal Service's equity. Entering FY 2001, the
Postal Service had accumulated losses of \$3.7 billion. The projected
losses of over \$3 billion in FYs 2001 and 2002 almost double that
amount. Application of the 9-year amortization period, which has been
used in each rate case starting with Docket No. R80-1, results in a
\$633 million annual provision for the recovery of prior years' losses.
This amount has been computed by summing the net operating income (loss)
for all periods from the inception of the Postal Service to the
beginning of the Test Year, deducting the funds received under Public
Law No. 94-421, and amortizing the total amount over nine years.
Computation of the amount included in the revenue requirement for
recovery of prior years\' losses is shown in Table 53.

The Prior Years' Losses Recovery provision is designed to restore the
Postal Service's equity that is dissipated when net losses are incurred.
After running a string of net losses from 1986 through 1994, the Postal
Service's Board of Governors adopted Board Resolution 95-9. This directs
the Postal Service to plan for net incomes over a rate cycle which
cumulatively will result in the recovery of prior years' losses during
the rate cycle which equal the annual amount included in the rates for
the PYLR times the number of years in

the rate cycle. The Board's Resolution responded to concerns expressed
by the Postal Rate Commission that the Postal Service was not using the
PYLR provision to actually recover past losses. The Postal Service is
committed to restoring past losses, as the Board affirmed in that
Resolution.

Through FY 2000, the Postal Service remained ahead of the Resolution's
PYLR recovery target included in this resolution (see Exhibit USPS-6N).
When the Board was informed of projections that the Postal Service would
fall behind the target beginning in FY 2001, the Board, in accordance
with the Resolution, ordered management to prepare the current rate
filing.

Regarding PYLR, the Postal Service is not satisfied with the progress
recently made towards the statutory and policy objectives of breaking
even and restoring equity. The related cash shortfall has precipitated
the freeze on capital spending.[^38] This freeze will have been in place
for 20 months by the beginning of the test year. Getting back into a
mode of recovering prior years' losses is necessary to restore the
Postal Service's financial health and to allow the Postal Service to
resume its capital program at appropriate levels. Recovery of prior
years' losses will supply funds that can be used to retire debt and free
the Postal Service to manage its capital program for the benefit of its
customers

The full range of issues relating to Prior Years' Loss Recovery was
addressed in the testimony of Postal Service witness Bjorn in Docket No.
R94-1 and the ensuing report to Postal Service management, which was
filed as Library Reference SSR-112 in Docket No. MC96-3.

The report noted at page 4 the following benefits of a positive equity
position:

-   A buffer against unexpected costs and economic cycles

-   Flexibility in pricing;

-   An internal source for financing

-   Enhanced security for future obligations such as retirement and
    health care benefits;

-   A basis from which to pay dividends to stakeholders

-   Credibility with outside constituencies; and

-   A signal to stakeholders that the enterprise is being well managed.

    Mr. Bjorn recommended that equity restoration should become a high
    priority for the Postal Service. The only means the Postal Service
    currently has of planning to develop positive equity is through
    PYLR.

    Looking at equity from the other side, the impacts that negative
    equity is having on the Postal Service are quite predictable.

-   Negative equity has made it extremely difficult for the Postal
    Service to absorb natural economic slowdowns and has significantly
    reduced its financial flexibility.

-   The Postal Service has exhausted its sources of financing. The
    recent economic slowdown has worked in concert with the lack of
    equity to reduce the cash available to fund capital.

-   Negative equity is driving up the portion of the revenue requirement
    that represents the past and reduces the extent that rates reflect
    current and projected operations.

-   The Postal Service is not able to time rate cases to coincide with
    conditions in the competitive environment in which both it and its
    customers operate.

-   Debt is higher than it would otherwise be which magnifies the risks
    of future obligations and increases interest expense.

-   Poor financial performance has drawn attention away from other
    indicators of strong operational performance, including improvements
    in service and recent surges in productivity growth.

    **Table 53**

Computation of Prior Years\' Loss Recovery

(\$ 000)

  ---------------------------------------------------- ------------------
  Deficit from Operations since commencement on July   3,679,744
  1, 1971 through September 30, 2000                   

  Plus: Estimated net loss in FY 2001                  1,666,394

  Plus: Estimated net loss in FY 2002                  1,349,138

  Less: Funds from Public Law No. 94-421               1,000,000

  Total Recovery Required                              5,695,276

  Annual Increment (1/9)                               632,808
  ---------------------------------------------------- ------------------

IV\. REVENUES BEFORE AND AFTER RATES

The three sources of postal revenues are operating revenue,
appropriations, and interest income. Table 54 provides total revenues,
actual and estimated through the Test Year:

**Table 54**

Total Revenues

(\$ 000)

  ----------------------------------------- -----------------------------
  FY 2000                                   64,581,009

  FY 2001                                   66,343,978

  FY 2002                                   68,823,489

  Test Year before rates                    70,583,310

  Test Year after rates                     74,839,814
  ----------------------------------------- -----------------------------

A. Mail and Special Services Revenues[^39]

The mail classes, together with special and other services provided to
the public, yield the largest portion of total operating revenues. The
derivation of mail and special services revenue is explained in the
testimony and workpapers of each of the individual pricing witnesses and
summarized in the Testimony of witness Moeller (USPS-T-28).

Revenues for mail and special services through the Test Year are shown
in the following table:

**Table 55**

Mail and Special Services Revenue

(\$ 000)

  ----------------------------------------- -----------------------------
  FY 2000                                   64,475,556

  FY 2001                                   66,243,790

  FY 2002                                   68,746,770

  Test Year before rates                    70,523,553

  Test Year after rates                     74,780,057
  ----------------------------------------- -----------------------------

B. Appropriations[^40]

Prior to Fiscal Year 1983, the Postal Service received annual
appropriations for public service costs. However, since Fiscal Year
1982, appropriation revenue has been for revenue forgone only.
Currently, revenue forgone results from providing free mail for the
blind and for overseas voters.

The appropriation revenue included in this filing consists of two
components. The first represents the estimated cost of providing free
mail for the blind and visually handicapped and overseas voting. As
reflected in my Exhibit 9E, this amounts to \$48.999 million for the
test year. The second component is a preliminary estimate of \$(18.142)
million for the reconciliation adjustment relating to Fiscal Year 2000
to reconcile the appropriation received to the amount that would have
been authorized if based on the final audited mail volume. (The FY 2000
and 2001 appropriation revenue in my Exhibit 6E also includes a third
component of \$(.270) million and \$(.205) million respectively. These
amounts relate to Federal Budget recissions that occurred in those
years.

During Fiscal Years 1991-1993, the amounts appropriated were not
sufficient to fund the services provided by the Postal Service. The
Revenue Forgone Reform Act of 1993 authorized the appropriation of
\$1.218 billion in 42 annual \$29 million payments through Fiscal Year
2035, to reimburse the Postal Service for earned but unpaid revenue
forgone for Fiscal Years 1991--1993, and for the estimated revenue
forgone during the period Fiscal Years 1994--1998. During FYs
1994--1998, the revenue forgone appropriation was gradually phased out
and reduced rates were gradually increased until half of the amount
necessary to provide full funding was provided by the rates charged to
users for all previously subsidized categories of mail except free mail
for the blind and absentee overseas voters, which remain fully
subsidized. The remaining one-half of the shortfall is passed on to all
mail users through higher rates that result from the rate-making
process. Should any amount not be appropriated, the Postal Service can
adjust the rates of the subsidized mail categories enough to offset the
shortfall.

In recognition of the 42-year extended payment cycle of the Revenue
Forgone Reform Act of 1993, on September 30, 1993, the Postal Service
recorded as a receivable the present value of earned and unpaid revenue
forgone appropriations for FY 1991--1993. During FY 1994--1998
additional amounts were added to this receivable to recognize earned but
unpaid revenue as the higher rates were phased-in for certain categories
of subsidized mail. As each of the annual \$29 million appropriation
payments is received, a portion is recorded as imputed interest income
(because the account receivable was recorded at a present value
discounted at 7%) and the remainder is recorded as a partial collection
of the account receivable.

The Postal Service recently requested that this liability be liquidated
by a supplemental appropriation of \$957 million for FY 2002, or,
alternatively, if the full amount cannot be provided immediately, that
half be provided in FY 2002 and the balance be appropriated in FY 2003.
The impact of this request has not been reflected in the Postal
Service's filing.

Additional details regarding the calculation of these amounts can be
found in Chapter Xb and Xc of LR J-50.

The following table shows revenue forgone appropriation revenue through
the Test Year:

**Table 56**

Appropriation Revenue

(\$ 000)

  ---------------------------------------------- ------------------------
  FY 2000                                        64,165

  FY 2001                                        66,888

  FY 2002                                        47,619

  Test Year before rates                         30,857

  Test Year after rates                          30,857
  ---------------------------------------------- ------------------------

C. Interest Income

Interest income has two components: investment income and imputed
interest.

Investment income earned by the Postal Service in any period depends
upon prevailing short-term interest rates and the amount of cash
invested. Because the Postal Service has adopted a zero cash balance
goal as one of its financial management policies, minimal investment
income is projected through the test year.

Imputed interest results from the calculation at 7 percent interest of
the present value of future payments related to the Revenue Forgone Act
of 1993. The calculation of these amounts is discussed above under
appropriations and explained in detail in Chapter Xc of Library
Reference J-50.

The following table shows Interest income for Fiscal Year 2000 through
the Test Year:

**Table 57**

Interest Income [^41]

(\$ 000)

+------------------------+--------------+--------------+--------------+
| Period                 | Investment   | Imputed      | Total        |
|                        |              |              | Interest     |
|                        | Income       | Interest     | Income       |
+------------------------+--------------+--------------+--------------+
| FY 2000                | 14,987       | 26,300       | 41,287       |
+------------------------+--------------+--------------+--------------+
| FY 2001                | 7,000        | 26,300       | 33,300       |
+------------------------+--------------+--------------+--------------+
| FY 2002                | 3,000        | 26,100       | 29,100       |
+------------------------+--------------+--------------+--------------+
| Test Year before rates | 3,000        | 25,900       | 28,900       |
+------------------------+--------------+--------------+--------------+
| Test Year after rates  | 3,000        | 25,900       | 28,900       |
+------------------------+--------------+--------------+--------------+

V. TEST YEAR REVENUE DEFICIENCY

The Postal Service\'s total revenue deficiency in the Test Year at
present rates would be approximately \$5.3 billion. Changes in postal
rates and fees proposed in this filing will eliminate the deficiency as
illustrated below:

**Table 58**

Test Year Revenue Deficiency [^42]

(\$ 000)

  --------------------------------------------------- -------------------
  **Present Rates**                                   **Test Year**

  Total Revenue Requirement [^43]                     75,857,833

  Less: Total Revenue [^44]                           70,583,310

  Total Revenue Deficiency                            5,274,523

  **Proposed Rates**                                  

  Increase in Revenue                                 4,256,504

  Decrease in Revenue Requirement                     1,051,164

  Change in Revenue Deficiency                        5,307,668

  Revenue Surplus (Deficiency)                        33,145
  --------------------------------------------------- -------------------

The financial impact of present and proposed rates in the Test Year, as
represented in the equity section of the balance sheet, is demonstrated
in Table 59.

**Table 59**

Analysis of Changes in Equity [^45]

(\$ 000)

+-------------------+-----------+-----------+-----------+-----------+
|                   | FY 2001   | FY 2002   | Test Year | Test Year |
|                   |           |           |           |           |
|                   |           |           | Before    | After     |
|                   |           |           | Rates     | Rates     |
+-------------------+-----------+-----------+-----------+-----------+
| Beginning Balance | (645,280) | (         | (3        | (3        |
|                   |           | 2,312,214 | ,661,352) | ,661,352) |
+-------------------+-----------+-----------+-----------+-----------+
| Net Income/(Loss) | (1        | (1        | (4        | 665,954   |
|                   | ,666,394) | ,349,138) | ,641,714) |           |
+-------------------+-----------+-----------+-----------+-----------+
| Ending Balance    | (2        | (3        | (8        | (2        |
|                   | ,312,214) | ,661,352) | ,303,066) | ,995,398) |
+-------------------+-----------+-----------+-----------+-----------+

**EXHIBITS INDEX**

STATEMENTS OF REVENUE AND EXPENSE

FY 2000 - TEST YEAR AFTER RATES USPS-6A

ROLLFORWARD SOURCE OF CHANGE SUMMARIES,

FY 2000 THROUGH THE TEST YEAR AFTER RATES USPS-6B

MAIL VOLUME, FY 2000 THROUGH THE TEST YEAR

AFTER RATES USPS-6C

MAIL AND SPECIAL SERVICES REVENUE, FY 2000

THROUGH THE TEST YEAR AFTER RATES USPS-6D

APPROPRIATION REVENUE, FY 2000 THROUGH

THE TEST YEAR USPS-6E

STATEMENT OF CASH FLOWS, FY 2000 THROUGH THE

TEST YEAR AFTER RATES USPS-6F

INTEREST INCOME, FY 2000 THROUGH THE

TEST YEAR AFTER RATES USPS-6G

REVENUE REQUIREMENT, SUMMARY ANALYSIS

OF INCOME AND EXPENSES USPS-6H

COMPARATIVE STATEMENTS OF REVENUE AND

EXPENSE, TEST YEAR VS. ACTUAL (DOCKET R2000-1) USPS-6I

COMPUTATION OF WEIGHTED AVERAGE PERCENTAGE

REVENUE AND COST VARIANCES USPS-6J

OMNIBUS BUDGET RECONCILIATION ACT (OBRA) COSTS USPS-6K

SUMMARY OF NET INCOME (LOSS) & EQUITY USPS-6L

SUMMARY OF CHANGES IN ACCRUED COSTS BY SOURCE USPS-6M

NET INCOME (LOSS) GAP FROM EQUITY RESTORATION

TARGET USPS-6N

SUMMARY OF UNIT LABOR COSTS FOR MAJOR

EMPLOYEE GROUPS USPS-6O

SUMMARY OF CHANGES IN WORKYEARS BY SOURCE USPS-6P

ANALYSIS OF CHANGES IN PERSONNEL COSTS USPS-6Q

ADJUSTMENT OF ROLLFOWARD COST FOR WORKYEAR USPS-6R

MIX AND FINAL ADJUSTMENTS

WORKERS' COMPENSATION DISCOUNT RATE ANALYSES USPS-6S

FY HISTORY OF KEY OPERATING AND COST LEVEL USPS-6T

INDICATORS

[^1]: ^/^ The various fiscal or other periods discussed in this
    testimony include the following:

    The Test Year (FY 2003) - October 1, 2002 to September 30, 2003

    Fiscal Year 2002 - October 1, 2001 to September 30, 2002

    Fiscal Year 2001 - October 1, 2000 to September 30, 2001

    The Base Year (FY 2000) - October 1, 1999 to September 30, 2000

[^2]: ^/^ Includes OBRA 1991 extraordinary retroactive assessment for
    employee benefits (\$1,810 million).

[^3]: ^/^ Includes restructuring costs of \$1,010 million.

[^4]: ^/^ Includes OBRA 1993 (\$857 million) and debt refinancing
    premium (\$536.5 million).

[^5]: ^/^ Includes interest income and appropriations.

    ^[6]{.underline}/^ Includes interest expense and all extraordinary,
    unusual, and non-recurring expenses.

[^6]:

[^7]: ^/^ Includes interest income and appropriations.

    ^[8]{.underline}/^ Includes interest expense and all extraordinary,
    unusual, and non-recurring expenses.

[^8]:

[^9]: Includes Servicewide Costs, excludes Travel and Relocation.

[^10]: FY 1994 though FY 1996 from USPS Operating Statistics. FY 1997
    from LR-H-12. FY 1998 from Exhibit USPS-9P, Docket No. R2000-1. FY
    1999 from LR-I-127. FY 2000 from Annual Report of the Postmaster
    General, FY 2000. FY 2001 from LR-J-50.

[^11]: ^/^ Excludes the asset Deferred Retirement Costs and the
    long-term liability Amounts Payable for Retirement Benefits. The
    current liability portion of Amounts Payable for Retirement Benefits
    has been included as a liability.

[^12]: Board of Governors Resolution No.95-9 (July 10, 1995), filed in
    Docket No. MC96-3, Library Reference SSR-112.

[^13]: Final adjustments are calculated by other witnesses and
    summarized and sourced in witness Patelunas' Exhibit USPS-12A.

[^14]: Exhibits 6A, 6B, and 6R.

[^15]: Weighted by Postmaster salaries by class.

[^16]: Weighted average.

[^17]: The \$2.6 billion in net savings is the sum of Field Operating
    Programs (\$1.1), Breakthrough Productivity (\$1.4 billion) and
    Trend/Base Adjustment (\$0.1 billion).

[^18]: Includes BPI savings of \$351 million, \$400 million, and \$350
    million in Fiscal Years 2001, 2002, and 2003 respectively.

[^19]: ^/^ DRI/WEFA is a leading economic forecasting service.

[^20]: CPI-W is the Consumer Price Index for all Urban Wage Earners &
    Clerical Workers

[^21]: ECI is the Employment Cost Index for Wages and Salaries, Private
    Industry. The ECI growth factors used in this testimony reflect the
    September index over the previous September index.

[^22]: Includes workyear mix and final adjustments. Excludes contingency
    and recovery of prior years' losses.

[^23]: Exceptions to the freeze are available for emergencies, to ensure
    safety, and to satisfy legal obligations.

[^24]: The actual number or facilities will vary depending on factors
    such as shifts in population centers, carrier productivity programs,
    and specific local needs. Shifts in population centers place demands
    on the system for growth that is disproportionate to delivery point
    increases because facilities are not transferable from area to area.
    In some cases, growth can be served by repair or alteration of an
    existing facility rather than by building a new facility.

[^25]: In addition to new facilities, assuming that half the new routes
    are city routes, there would be a requirement for 1,700 new
    vehicles, which at \$20,000 per vehicle, translates into an
    additional capital requirement of \$34 million.

[^26]: An example of an uncertain and surprising result is the outcome
    of the latest city carrier contract arbitration. That contract gave
    city carriers a 1.2-percent general pay increase and a 2.9 percent
    grade level increase in FY 2001. See Exhibit USPS-6O. That contract
    also provides for FY 2001 COLA increases which sum to \$961.03 or
    2.7 percent on an effective basis. The total FY 2001 wage increase
    for city carriers is then 6.8 percent, which is more than twice the
    rate of inflation.

[^27]: Using FY 2000 expense, total personnel costs (including
    servicewide expenses) are \$49,696 million or 76.7 percent of the
    total expense of \$64,781 million. Transportation related expenses
    include Rural EMA (\$365 million), Vehicle Hire (\$50 million),
    Transportation of Supplies (\$27 million), Carfare, Tolls and
    Carrier Driveouts (\$62 million) and Transportation of Mail (\$4,721
    million). The total base year transportation expense then is \$5,225
    million or 8.1 percent of total expenses.

[^28]: I am not testifying that the contingency pays for network growth.
    We strive to design rates that include adequate markups to
    compensate for network growth. I am testifying, however, that the
    Postal Service's obligation to serve its delivery network without
    regard to volume or revenue growth makes an adequate contingency
    vitally important. The Postal Service has no realistic options to
    limit deliveries or eliminate portions of its network to respond to
    adversity in order to reduce costs.

[^29]: The Postal Service's pay-for-performance program for
    non-bargaining staff, managers and executives indexes out the impact
    of rate increases from the payment pool. Therefore, these employees
    and executives receive no credit for rate increases.

[^30]: As of July of 2001 when we locked into the macroeconomic
    assumptions which drive this filing, the Gross Domestic Product
    (GDP) growth for the latest quarter (Spring) was estimated at 0.7
    percent. In late August this estimate was dropped to 0.2, which was
    the lowest quarterly growth since 1993.

[^31]: The Commission's contingency was published in a recommended
    decision issued on November 13^th^, after the the R2000-1 test year
    had already started. This level of revenue mis-estimation so far
    along in the process belies the notion that the contingency
    provision should be reduced as the test year becomes closer in time
    to the close of the record. The Postal Service's contingency is
    developed with the full awareness that it will be applied in a
    decision issued ten months after the case is filed. It is developed
    with the expectation and understanding that it will not be reduced
    due to the passage of time between now and the issuance of the
    Commission's recommended decision. Recent experience with the
    economy has buttressed Postal Service management's view that the
    passage of time can lead to increased risk, and belies the notion
    that risk automatically dissipates with the passage of time.

[^32]: Noriman Behravesh, Andrew Hodge, and Cynthia Latta DRI-WEFA, The
    U.S. Economy, "Hanging By a Thread", June 2001.

[^33]: Noriman Behravesh, Andrew Hodge, and Cynthia Latta DRI-WEFA, The
    U.S. Economy, "Waiting It Out", July 2001.

[^34]: Noriman Behravesh, Andrew Hodge, and Cynthia Latta DRI-WEFA, The
    U.S. Economy, "Still Afloat", August 2001.

[^35]: Greg Schneider and Carol Vinzant, *Stocks Fall for 4^th^ Straight
    Day,* [Washington Post]{.smallcaps}, September 21, 2001, E1.

[^36]: Though we have not relied on these to develop our three percent
    contingency provision, the Commission's traditional variance
    calculations are presented for information purposes in Exhibit
    USPS-6J.

[^37]: General ledger account classifications were realigned in FY 1995.
    Material shifts were made among segments 16, 18, and 20. Weighted
    average historical percentage variances which are impacted by FY
    1995 data were therefore based on the variances for these three
    segments in total.

[^38]: As mentioned above, inadequate revenues, large net losses and
    cash outflows have required the Postal Service to freeze the
    facilities portion of its capital program. Other capital purchases
    have been deferred. The Postal Service is not currently able to plan
    and invest for the long-term benefits of its customers -- the Postal
    Service is limited by the pressing and immediate needs of cash flow
    and liquidity.

[^39]: ^/^ Volumes by class of mail and the attendant revenues for FYs
    2000, 2001, 2002, and the Test Year before and after rates are shown
    in my Exhibits 6C and 6D. The development of volume estimates is
    included in the testimonies and workpapers of witnesses Tolley,
    Thress, and Musgrave (USPS-T-7,8, & 9). After rates volume
    adjustments that result from market research or special studies are
    explained in the testimony of the appropriate pricing witness.

[^40]: ^/^ My Exhibit 9E shows the components of appropriation revenue
    for the relevant years.

[^41]: ^/^ Estimated cash flows for FY 1999, FY 2000 and the Test Year
    before and after rates, along with projected investment income, are
    shown in my Exhibits 9F and 9G.

[^42]: ^/^ An analysis of changes in income and expenses comparing
    before and after rates is included in my Exhibit 9H.

[^43]: ^/^ From Table 15, the Test Year revenue requirement before and
    after rates reflects, total accrued cost segment expense, final
    adjustments, contingency and recovery of prior years' losses.

[^44]: ^/^ From Table 54, revenues for the Test Year at present rates.

[^45]: ^/^ The contingency is included and the prior year loss recovery
    is excluded from test year costs when determining net income (loss)
    and equity.