Tennessee Valley Authority: Actions Needed to Better Communicate Debt Reduction Plans and Address Billions in Unfunded Pension Liabilities
Published: 2017-03-23T00:00:00

Fast Facts:
The Tennessee Valley Authority, the nation's largest public power provider, provides electricity to more than 9 million customers. It raises billions in revenue but also issues bonds to finance its large capital investments (though it is subject to a $30-billion debt limit).
The TVA plans to reduce its debt by about $4 billion by 2023 by increasing rates and reducing expenses; it also plans to eliminate its unfunded pension liabilities.
However, we found that its debt reduction goals and plans haven't been reported as required. We recommended that it do so, and that it take steps to ensure that its pension plan is fully funded.

Highlights:
section_title: Why GAO Did This Study
paragraphs: TVA, the nation's largest public power provider, is a federal electric utility with revenues of about $10.6 billion in fiscal year 2016. TVA's mission is to provide affordable electricity, manage river systems, and promote economic development. TVA provides electricity to more than 9 million customers in the southeastern United States. TVA must finance its assets with debt and operating revenues. TVA primarily finances large capital investments by issuing bonds but is subject to a statutorily imposed $30 billion debt limit. In fiscal year 2014, TVA established a debt reduction goal.
GAO was asked to review TVA's plans for debt reduction. This report examines (1) TVA's debt reduction goal, plans for meeting its goal, and key assumptions; (2) the extent to which TVA reports required performance information; and (3) factors that have been reported that could affect TVA's ability to meet its goal. GAO analyzed TVA financial data and documents and interviewed TVA and federal officials and representatives of stakeholder and industry groups.
section_title: What GAO Found
paragraphs: To meet its goal to reduce debt by about $4 billion—from about $26 billion in fiscal year 2016 to about $22 billion by fiscal year 2023—the Tennessee Valley Authority (TVA) plans to increase rates, limit the growth of operating expenses, and reduce capital expenditures. For example, TVA increased rates each fiscal year from 2014 through 2017 and was able to reduce operating and maintenance costs by about 18 percent from fiscal year 2013 to 2016. TVA's plans depend on assumptions that future capital projects will be completed on time and within budget, but TVA's estimated capital costs may be optimistic and could increase.
TVA's debt reduction plans and performance information are not reported in a manner consistent with the GPRA Modernization Act of 2010. Specifically, TVA identifies managing its debt and its unfunded pension liabilities as major management challenges but has not reported required performance information in its performance plans or reports on these challenges, thereby reducing transparency and raising questions about how it will meet its goal. As of September 30, 2016, TVA‘s pension plan was about 54 percent funded (plan assets totaled about $7.1 billion and liabilities $13.1 billion). While TVA's debt has remained relatively flat, its unfunded pension liabilities have steadily increased over the past 10 years, as shown below.
Tennessee Valley Authority's Debt and Unfunded Pension Liabilities, Fiscal Years 2006 through 2016
Several factors could affect TVA's ability to meet its debt reduction goal, including regulatory pressures, changes in demand for electricity, technological innovations, or unforeseen events. Also, TVA aims to eliminate its unfunded pension liabilities within 20 years, according to TVA officials. However, factors such as market conditions could affect TVA's progress, and no mechanism is in place to ensure it fully funds the pension liabilities if, for example, plan assets do not achieve expected returns. The TVA retirement system rules that determine TVA's required annual pension contributions do not adjust TVA's contributions to ensure full funding and TVA does not plan to contribute more than the rules require. Without a mechanism that ensures TVA's contributions will adequately adjust for actual plan experience, unfunded liabilities could remain and future ratepayers may have to fund the pension plan even further to pay for services provided to prior generations of ratepayers.
section_title: What GAO Recommends
paragraphs: GAO recommends that TVA (1) better communicate its plans and goals for debt reduction and reducing unfunded pension liabilities in its annual performance plan and report and (2) take steps to have its retirement system adopt funding rules designed to ensure the pension plan's full funding. TVA agreed with the first recommendation and neither agreed nor disagreed with the second. GAO believes that action is needed as discussed in the report.

section_title: Letter
paragraphs: The Tennessee Valley Authority (TVA)—the nation’s largest public power  provider—is a federal electric utility with revenues of about $10.6 billion in  fiscal year 2016. TVA’s mission is to provide affordable electricity,  manage river systems, and promote economic development in the  Tennessee Valley. TVA provides electricity to more than 9 million  customers, and its service area covers about 80,000 square miles across  seven states in the southeastern United States. TVA must finance its  assets with debt and operating revenues—primarily from selling power.  TVA is a wholesaler of power to 154 local power companies that resell  electricity to consumers. TVA also sells electricity directly to industrial  customers and federal entities. Unlike many utilities, state public utility  commissions do not review or approve TVA’s rates, but its Board of  Directors must comply with the requirements of the TVA Act, including the  sale of power at the lowest feasible rates. In addition to providing  electricity, TVA engages in flood control and environmental stewardship  activities that include managing the Tennessee River and federal lands  along the shoreline to provide navigation, flood damage reduction,  recreational opportunities, adequate water supply, improved water quality,  and natural resource protection.
TVA primarily finances large capital investments, such as the construction  of nuclear power plants, by issuing bonds, and it also enters into  alternative financial arrangements. TVA has a statutorily-imposed $30  billion debt limit on bonds and notes and “other evidences  of  indebtedness.” As of September 30, 2016, TVA’s debt totaled about $26  billion—about $24 billion in bonds and notes (debt TVA considers subject  to the debt limit and refers to as statutory debt) and about $2 billion in  other financing obligations, such as lease-leasebacks and energy  prepayments. We have previously reported on TVA’s management of its  high levels of debt. In October 2011, we found that TVA may face  challenges making planned large capital investments because of existing  debt and statutory requirements to keep its rates as low as feasible. In  April 2015, at a hearing before the Subcommittee on Water Resources  and Environment of the House Transportation and Infrastructure  Committee, TVA’s Chief Executive Officer (CEO) said that TVA had a 10- year plan to reduce its debt to about $21 billion by about 2023—the fourth  debt reduction plan in 2 decades. Prior plans did not meet their goals.
TVA’s activities, particularly its power generation activities, are subject to  Environmental Protection Agency (EPA) regulations in a variety of areas,  including air and water quality control and management and disposal of  solid and hazardous wastes. TVA is also subject to certain aspects of  Federal Energy Regulatory Commission jurisdiction that affect TVA’s  generation and transmission system and Nuclear Regulatory Commission  (NRC) requirements for licensing, operation, and decommissioning of its  nuclear generating facilities. NRC also has authority to impose fines, shut  down units, or modify, suspend, or revoke operating licenses.
You asked us to review TVA’s plans for debt reduction. This report  examines (1) TVA’s debt reduction goal, plans for meeting its goal, and  key assumptions; (2) the extent to which TVA reports required  performance information; and (3) factors that have been reported that  could affect TVA’s ability to meet its debt reduction goal. To address all of  our objectives, we reviewed TVA documentation including its long range  financial plan, strategic plan, annual reports, and budget submissions. We  also reviewed financial data from TVA’s annual reports (audited financial  information reported on the Securities and Exchange Commission Form  10-K) including revenues; debt; pension and other liabilities; and  expenditures such as operating and maintenance (O&M), interest, and  capital. In this report, unless otherwise indicated, when we refer to TVA’s  pension funding—unfunded liabilities and funded ratios—we are referring  to the Projected Benefit Obligations TVA discloses in its financial  statements. We also obtained data from TVA on historical and projected  revenue, debt, capital expenditures, and O&M expenses. To assess the  reliability of these data, we reviewed documentation, corroborated the  data with TVA’s audited financial statements and other published sources  of the data, and consulted with knowledgeable officials. We compared  TVA’s projections with historical data and information from TVA’s capital  expenditure, resource, and other business plans to determine how they  compared with these sources and whether relevant costs and revenue  sources were considered. We determined that the data were sufficiently  reliable for the purposes of our review.
We also reviewed legislation and other sources of TVA’s financial,  planning, and reporting requirements and policy including the TVA Act,  the GPRA Modernization Act of 2010 (GPRAMA), the Office of  Management and Budget (OMB) Circular A-11 and Circular A-136, and  TVA board and other policies and compared these sources with TVA’s  debt reduction plans. We reviewed our prior reports and those of the  Congressional Budget Office (CBO), TVA Office of Inspector General  (OIG), and others to identify key issues TVA faces and factors that could  affect TVA’s ability to meet its goals. We identified these reports based on  discussions with CBO and TVA OIG officials, searches of their websites,  and recommendations of federal officials and representatives of  stakeholder groups. We interviewed TVA and TVA OIG officials and  others knowledgeable about TVA, its goals and assumptions, issues  facing the utility and the industry, and TVA’s service area. We identified  and selected a nongeneralizable sample of federal officials and  representatives of industry and stakeholder groups to interview by  reviewing TVA documents; reviewing our prior reports and those of CBO  and OIG; and obtaining recommendations during our interviews about  others we could interview who were knowledgeable about TVA. We  interviewed federal officials from the Department of Energy’s (DOE)  Energy Information Administration (EIA), EPA, NRC, the Federal Energy  Regulatory Commission, CBO, OMB, and the Department of the  Treasury. We interviewed representatives of industry and stakeholder  groups including the American Public Power Association, Edison Electric  Institute, North American Electric Reliability Corporation, Nuclear Energy  Institute, SERC Reliability Corporation, TVA Retirement System (TVARS)  Board, Tennessee Valley Public Power Association, Tennessee Valley  Industrial Committee, Southern Alliance for Clean Energy, and Southern  Environmental Law Center. We also interviewed officials with credit rating  institutions including Moody’s, Standard & Poor’s, and Fitch. Information  obtained from our interviews cannot be generalized to those officials or  representatives we did not interview.
We conducted this performance audit from August 2015 to March 2017 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: This section describes TVA’s (1) legislation and governance, (2)  operations and planning, (3) debt ceiling, and (4) retirement system.
subsections: section_title: Legislation and Governance
paragraphs: TVA is an independent federal corporation established by the TVA Act.  The act established TVA to improve the quality of life in the Tennessee  River Valley by improving navigation, promoting regional agricultural and  economic development, and controlling the floodwaters of the Tennessee  River. To those ends, TVA built dams and hydropower facilities on the  Tennessee River and its tributaries. From its inception in 1933 through  fiscal year 1959, TVA received annual appropriations to finance its cash  and capital requirements. In 1959, however, Congress amended the TVA  Act and provided TVA with the authority to finance its power program  through revenue from electricity sales and borrowing and required it to  repay a substantial portion of the annual appropriations it had received to  pay for its power facilities. Under the TVA Act, TVA must design its rates  to cover all costs but also keep rates as low as feasible. TVA must charge  rates for power that will produce gross revenues sufficient to provide  funds for its costs including operating, administrative and maintenance  costs. TVA can borrow by issuing bonds and notes, an authority set by  Congress that cannot exceed $30 billion outstanding at any given time.
Legislation also limits competition between TVA and other utilities. When  the TVA Act was amended in 1959, it prohibited TVA, with some  exceptions, from entering into contracts to sell power outside the area  where it or its distributors were the primary source of power supply on  July 1, 1957. This is commonly referred to as the “fence,” because it limits  TVA’s ability to expand substantially outside its service area. In addition,  the Federal Power Act includes a provision that helps protect TVA’s ability  to sell power within its service area. This provision, called the “anti- cherrypicking” provision, exempts TVA from being required to allow other  utilities to use its transmission lines to deliver power to customers within  its service area. The anti-cherrypicking provision reduces TVA’s  exposure to loss of customers and competition from other utilities.
A nine-member Board of Directors nominated by the President and  confirmed by the U.S. Senate administers TVA. The board sets TVA’s  goals and policies, appoints the CEO, develops long-range plans, seeks  to ensure those plans are carried out, and approves TVA’s budget. The  board also approves rate changes and has the sole authority to set  wholesale electric power rates and approve the retail rates charged by  TVA’s distributors. TVA’s board approves the agency’s strategic plan  which outlines TVA’s broad goals, priorities, and performance measures.  TVA’s most recent strategic plan covers fiscal years 2014 through 2018  and outlines its “strategic imperatives”—namely, to “maintain low rates,  live within our means, manage our assets to meet reliability expectations  and provide a balanced portfolio, and be responsible stewards of the  region’s natural resources.”
In August 2013, TVA’s board approved the goal to reduce TVA’s debt to  about $22 billion by fiscal year 2023. TVA developed this goal during its  fiscal year 2014 long-term financial planning process, but TVA updates its  long range financial plan each year. The TVA board approves the budget  each fiscal year, and the board is updated at least semi-annually on the  long-range financial plan. TVA uses a 10-year long-range financial plan to  determine the amount of funds that will be available for capital  investment. Operating priorities are detailed in business unit plans, such  as the power supply plan, the transmission assessment plan, and the coal  and gas operations asset plan. In addition, TVA files publicly available  quarterly and annual financial reports with the Securities and Exchange  Commission. TVA also submits a budget proposal and management  agenda (performance report) to Congress and a performance budget  (performance plan) to OMB.
section_title: Operations and Planning
paragraphs: To meet demand for electricity, utilities can construct new plants, upgrade  existing plants, purchase power from others, and provide incentives to  customers to reduce and shift their demand for electricity through energy  efficiency or demand-response programs. Since its establishment, to  meet the subsequent need for more electric power, TVA has expanded  beyond hydropower to other types of power generation such as natural  gas, coal, and nuclear plants. In fiscal year 2016, TVA provided nearly  159 billion kilowatt-hours to customers from its power generating facilities  and purchased power, as shown in figure 1.
To guide TVA decisions about the resources needed to meet future  demand for electricity and determine the most cost-effective ways to  prepare for the future power needs of its customers, TVA periodically  develops an integrated resource plan (IRP). TVA’s 2015 IRP found no  immediate needs for new baseload plants—plants that generally have  been the most costly to build but have had the lowest hourly operating  costs—beyond the completion of the Watts Bar Unit 2 nuclear plant in  Tennessee and the expansion of capacity at the Browns Ferry nuclear  plant in Alabama. In October 2016, TVA completed Watts Bar Unit 2— the first nuclear unit to enter commercial operation in 20 years. Beyond  those projects, the 2015 IRP found that TVA could rely on additional  natural gas generation, greater levels of cost-effective energy efficiency,  and increased contributions from competitively priced renewable power.
TVA develops forecasts of demand for electricity that help it make  resource planning decisions, such as how much and what kind of  capacity to build, how much power to buy from other sources, or how  much to invest in energy efficiency. To forecast the demand for electricity  in its service area for the next 20 or more years, TVA employs a set of  models but forecasting beyond a few years into the future involves great  uncertainty. Utilities deal with uncertainty partly by producing a range of  forecasts based on demographic and economic factors, and by  maintaining excess generating capacity, known as reserves. Models help  utilities choose the least-cost combination of generating resources to  meet demand. If demand forecasts are unreasonably high or low, a utility  could end up with more or less generating capacity than it needs to serve  its customers reliably, or it could end up with a mix of generating capacity  that is not cost effective. These outcomes can affect electricity rates as  well as the utility’s financial situation. TVA experienced less than  anticipated electricity demand growth over the past 20 years and now  forecasts little, if any, growth in demand for electricity in the upcoming  years.
section_title: Debt Ceiling
paragraphs: Congress increased TVA’s debt ceiling four times from 1966 to 1979,  from $750 million to $30 billion. In the years following these increases,  TVA’s financial condition worsened, largely as the result of construction  delays, cost overruns, and operational shutdowns in its nuclear program.  In the late 1960s and 1970s, TVA started construction on 17 nuclear units  but completed only 7 because of lower-than-anticipated demand for  electricity, resulting in billions of dollars of debt. In February 2001, we  reported that TVA had about $6.3 billion in unrecovered capital costs  associated with uncompleted and nonproducing nuclear units. In fiscal  year 2016, TVA had about $1.1 billion in unrecovered costs associated  with uncompleted nuclear units.
While the debt ceiling has not been changed since 1979, TVA’s business  and operations have grown along with the power needs of the Tennessee  Valley. TVA has continued to add generating capacity to the system, as  its customer base has increased, and environmental spending  requirements have increased. TVA generally uses debt financing for  capital investments in new generation capacity and environmental  controls and uses revenues for operation and maintenance of the power  system. TVA can borrow funds at competitive interest rates as a result of  its triple-A credit rating which is based, in part, on its ownership by the  federal government. Appendix I includes historical data on TVA’s debt  and other selected financial data.
section_title: Retirement System
paragraphs: TVA’s board established TVARS in 1939. TVARS is a separate legal  entity from TVA and is administered by a seven-member Board of  Directors. The TVARS board manages the retirement system, including  decision-making on investment portfolios, the interest rate or rates used  in actuarial and other calculations, and benefits. The Rules and  Regulations of the TVA Retirement System (TVARS Rules) establish how  the retirement system is administered and what benefits are payable to  participants. The TVARS Rules establish the minimum amount TVA  must contribute to the system each year. The TVARS board can amend  the TVARS Rules, but TVA has veto power and amendments proposed  by the TVARS board become effective only if TVA does not exercise its  veto within 30 days. As a governmental plan, TVA’s plan is not subject to  the Employee Retirement Income Security Act of 1974 (ERISA), which  sets minimum standards for pension plans in the private sector. As of  September 30, 2016, the defined benefit pension plan (which we refer to  as the pension plan in this report) had about 34,000 participants, of whom  about 24,000 were retirees; it is a “mature” plan, in that there are more  than twice as many retirees and beneficiaries as employees participating  in the plan.
section_title: TVA Plans to Reduce about $4 Billion in Debt by Raising Rates, Limiting the Growth of Operating Expenses, and Reducing Capital Expenditures
paragraphs: To meet its goal to reduce its debt from about $26 billion in fiscal year  2016 to about $22 billion by fiscal year 2023, TVA plans to increase  revenue through rate increases, limit the growth of operating expenses,  and reduce capital expenditures. TVA’s plans assume the completion of  capital projects will occur on time and within budget. TVA’s plans also  include costs for investigating the development of new nuclear technology  but do not include capital costs for construction.
subsections: section_title: TVA Plans to Increase Rates, Limit the Growth of Operating Expenses, and Reduce Capital Expenditures
paragraphs: According to TVA officials, TVA aims to increase its overall financial  flexibility over the long term to ensure sufficient room under the debt  ceiling so it can access capital for future investments to meet its mission.  TVA plans to gradually decrease debt through 2023 (see fig. 2).
To meet its goal to reduce its debt to about $22 billion by fiscal year 2023,  TVA’s plans include the following.
Rate increases. TVA’s plans include annual rate increases not to exceed  1.5 percent of the retail rate as needed to maintain its debt reduction  trajectory. According to TVA officials and documents, TVA’s plans  included rate increases of 1.5 percent for about $200 million in annual  revenue. TVA can use increased revenue to refinance existing debt or to  fund certain expenditures rather than taking on new debt, but TVA’s  board must approve rate increases. TVA increased rates each fiscal year  from 2014 through 2017. According to TVA officials, annual rate  increases through 2023 could result in the reduction of debt to about  $19.8 billion by fiscal year 2023, which would exceed the agency’s debt  reduction goal.
Limits in the growth of operating expenses. TVA plans to continue  evaluating its operations and to limit the growth of its operating expenses.  Having fewer operating expenses frees up revenue from rates that TVA  can use to repay outstanding debt or fund certain expenditures without  taking on new debt. In fiscal year 2016, TVA’s O&M expenses totaled  about $2.8 billion—a reduction of about 18 percent from $3.4 billion in  fiscal year 2013. As part of its cost-reduction initiatives, TVA eliminated  2,200 positions through attrition and elimination of vacant positions. TVA  plans to pursue additional workforce reductions to offset increases in  retirement benefit and labor costs. According to TVA documents,  reductions in expenses associated with coal plant closures will offset  some of the increase in labor-related costs but other reductions will be  required. TVA officials said that additional reductions could involve  contract labor in its nuclear group. In July 2016, TVA offered a voluntary  reduction-in-force program to all 3,500 employees in its nuclear group,  providing an opportunity to retire or depart; as of January 2017, TVA  officials had not provided information on the number of employees  participating in this program. In fiscal year 2016, TVA’s workforce  included 10,691 employees and 12,729 contractors. According to TVA  documentation, as a major component of its O&M costs, TVA  continuously evaluates its staffing levels, both employees and  contractors. TVA plans are being finalized, over the next several years, to  decrease the overall workforce through various mechanisms as TVA  aligns its workforce with changes to its generating assets; these  mechanisms may include reductions-in-force, attrition, and elimination of  vacant positions. However, early retirements and severance associated  with workforce reductions could also pose additional expenses.
Reductions in capital expenditures. TVA plans to reduce its capital  expenditures through fiscal year 2023. Over the past decade, TVA’s  capital expenditures increased by over 180 percent—from about $1.2  billion in fiscal year 2006 to about $3.4 billion in fiscal year 2015. TVA  aims to decrease capital expenditures to about $1.8 billion by fiscal year  2023 (see fig. 3).
Based on its electricity demand forecast, TVA does not anticipate the  need for additional baseload capacity until the 2030s beyond completion  of Watts Bar Unit 2—which cost about $4.7 billion—and capacity  expansion at three nuclear units. TVA’s capital expenditure plan from  fiscal years 2016 through 2023 includes a total of about $17.4 billion;  about $8.3 billion for base capital projects to maintain the current  operational state, about $5.2 billion for capacity expansion projects, and  about $3.9 billion for environmental and other projects. Under TVA’s  financial guiding principles, TVA may issue debt for new assets, including  capacity expansion and installation of environmental controls, but,  according to TVA officials, TVA plans to primarily fund capital  expenditures with revenue, as opposed to issuing new debt, to reach its  debt goal. TVA increased construction expenditures from fiscal years  2006 through 2016 from about $1.4 billion ($1.6 billion in 2016 dollars) to  about $2.7 billion while reducing the amount of new debt issued (see fig.  4).
section_title: TVA’s Plans Assume Completion of Capital Projects on Time and within Budget
paragraphs: According to TVA officials, TVA’s plans assume that the completion of  capital projects will occur on time and within budget. TVA’s plans included  the assumption that it would complete construction of a new nuclear  unit—Watts Bar Unit 2—in 2016. Watts Bar Unit 2 began commercial  operation in October 2016. By completing construction of this unit in  2016, a key assumption underlying TVA’s debt reduction plans was met.  However, TVA’s plans include other key capital projects such as the  construction of two natural gas plants, modification of a coal plant to  install clean air controls, and two smaller nuclear projects. Information  about these two nuclear projects follow.
Browns Ferry extended power uprate (EPU). TVA’s capital plans  include a project that aims to increase generation capacity at the Browns  Ferry nuclear plant’s three existing units. TVA began the project in 2001  and anticipated completion within 2 to 4 years but the project remains  incomplete. As of September 30, 2016, TVA reported that it anticipates  completion of the project by 2024 at a total estimated cost of about $475  million—an increase of 25 percent from an estimated $380 million in fiscal  year 2014. According to TVA documentation, the agency spent about  $191 million on the project through fiscal year 2016. The project involves  engineering analyses and modification and replacement of certain  existing plant components to enable the units to produce additional  power. To allow operation at the higher power level, the license for each  unit requires modification that would occur in parallel with the NRC  license amendment review process. TVA originally submitted the  licensing amendment requests to NRC in June 2004. However, TVA  withdrew these requests in September 2014 and submitted a new request  in September 2015. According to NRC, it is planning to complete its  review by fall 2017.
Watts Bar Unit 2 steam generator replacement. TVA’s capital plans  include about $438 million to replace steam generators at the newly  operational unit. The existing generators prematurely developed leaks  and other problems occurred at nuclear plants, including Watts Bar Unit 1  which required replacement of the generators 9 years into operation.  According to TVA officials, TVA has completed steam generator  replacements at other nuclear units without significant cost overruns or  schedule delays.
Given historical trends in nuclear construction, TVA’s estimated capital  costs may be optimistic and could increase. Any cost overruns or delays  on its nuclear or other capital projects could require adjustments to its  future financial plans. TVA’s history of cost overruns and schedule delays  includes the construction of Watts Bar Unit 2 which began commercial  operation in October 2016 after decades of construction (see table 1).
TVA did not complete another nuclear project. TVA auctioned off the  1,400 acre site of the Bellefonte nuclear plant in Alabama, including two  unfinished nuclear units, in November 2016 for $111 million—a fraction of  the approximately $5 billion TVA had spent on the plant. TVA began  building the plant in 1974, but several stops and starts in construction  occurred primarily as a result of lower-than-anticipated growth in  electricity demand. According to TVA officials, TVA decided again to  complete unit 1 in 2011 but stopped work in 2013 because of reduced  electricity demand, Watts Bar Unit 2 concerns, and anticipated increases  in construction costs. In 2013, TVA estimated that the cost to complete  the unit had grown from its prior approved cost of $4.9 billion to at least  $7.5 billion or more. TVA stated that it wanted to complete Watts Bar Unit  2 and await the results of its IRP process. Based on the 2015 IRP, TVA  decided not to complete construction of Bellefonte. According to TVA  documentation, TVA spent about $10 million to $12 million annually  maintaining the Bellefonte site. TVA’s plans do not anticipate any such  events occurring with its current projects that would interfere with timely  completion within budget.
section_title: TVA’s Plans Include Costs for Investigating New Nuclear Technology Although Its Study Concluded the Technology Is Cost-Prohibitive
paragraphs: TVA’s plans include costs for investigating the development of new  nuclear technology but do not include capital costs for construction of the  technology. Specifically, TVA is assessing the potential of its Clinch River  site in Tennessee for the construction of small modular reactors (SMR).  According to TVA documentation, these efforts include research and  development activities that support its technology innovation mission. In  2016, TVA submitted an early site permit application to NRC to assess  the suitability of the site for construction and operation of SMRs at its  1,200-acre Clinch River site. An early site permit is valid for up to 20  years and would address site safety, environmental protection, and  emergency preparedness associated with any of the light-water reactor  SMR designs under development in the United States. According to TVA  documentation, TVA has not selected a technology and has not entered  into any contracts for design work.
If TVA decides to construct SMRs, its costs are uncertain but could total  about $3 billion after cost sharing through public-private partnerships but  expenditures prior to a construction decision would be a very small  portion of this cost, according to TVA documentation. The total estimated  costs for TVA to develop, submit, and support the NRC application and  review include about $72 million, according to an interagency agreement  with DOE, and TVA is responsible for half of these costs. According to  TVA documentation, the agency spent about $23 million on SMR  activities through fiscal year 2015 and estimates spending about $5  million in fiscal year 2016. According to TVA, it spends about $10 million  to $15 million on research and development activities each year as part of  its technology innovation organization (not including spending on SMRs).  TVA officials said that the agency will not decide whether or not to  construct SMRs for at least 5 years. However, TVA is investigating SMRs  even though its 2015 IRP found that TVA does not need additional  baseload power plants beyond the projects currently under way and that  SMRs are cost-prohibitive.
section_title: TVA Has Not Reported Required Performance Information on Its Debt Reduction Plans and Its Performance Goals Do Not Address Billions in Unfunded Pension Liabilities
paragraphs: TVA’s debt reduction plans and performance information are not reported  in a manner consistent with GPRAMA requirements. GPRAMA requires  agencies, including TVA, to report major management challenges that  they face, and for each major management challenge that agencies  develop and report performance information—including performance  goals, measures, milestones, and planned actions to resolve the  challenge. TVA identifies managing debt and its unfunded pension  liabilities as major management challenges but TVA has not reported  required performance information in its annual performance plan or report  on these challenges.
For managing debt, TVA’s CEO stated a goal for debt reduction by 2023  during a congressional hearing in April 2015 and the goal is reported in  internal documents and Board presentation slides available on TVA’s  website. In addition, according to TVA’s 2016 performance report, its  strategic objectives include “effectively manage debt to ensure long-term  financial health.” TVA’s 2016 performance report includes a goal related  to total financing obligations for fiscal years 2016 and 2017, but the goal  shows these obligations increasing, and the report does not include  information on planned actions to resolve the challenge. Although TVA  established a goal to reduce its debt, it has not documented in its annual  performance plan or report strategies for how it will meet its goal, as  required by GPRAMA, thereby reducing transparency and raising  questions about how the agency will meet its goal.
For TVA’s unfunded pension liabilities, TVA officials have stated a goal to  eliminate the pension funding shortfall (about $6 billion at the end of fiscal  year 2016) by 2036, but TVA has not identified such a goal or milestones  in its performance plan or report. As of September 30, 2016, TVA’s  pension plan was about 54 percent funded with a funding shortfall of  about $6 billion (plan assets totaled $7.1 billion and liabilities $13.1  billion). While TVA’s debt has remained relatively flat, its unfunded  pension liabilities have steadily increased over the past 10 years (see fig.  5).
Unfunded pension liabilities are similar to other kinds of debt because  they constitute a promise to make a future payment or provide a benefit.  According to a joint American Academy of Actuaries and Society of  Actuaries task force, a pension plan needs to be evaluated as part of a  plan sponsor’s overall enterprise; an analysis that looks at the pension  plan as a self-standing entity is incomplete and too narrow. However, TVA officials told us that because TVA uses revenue from the rates it  charges customers to fund the pension, and not debt in the form of  bonds, unfunded pension liabilities would not affect TVA’s debt reduction  plan. In addition, TVA defers pension costs as “regulatory assets”— incurred costs deferred for recovery through rates in the future—in  accordance with accounting standards and with TVA board approval.  However, because TVA will need to recover these costs through rates in  the future, this affects its financial health and operations. If TVA uses  revenue from rate increases to close the pension shortfall, this could  decrease its ability to fund other activities such as capital projects with  revenue from rates. This could, in turn, require TVA to rely on debt to fund  certain capital projects and interfere with efforts to meet overall debt  reduction goals. Alternatively, further rate increases could interfere with  TVA’s objective of keeping rates as low as feasible. Without the Board of  Directors ensuring that TVA better document and communicate  information about its goals to reduce debt and unfunded pension liabilities  in its performance plan and report, including strategies for achieving its  goals, congressional and other stakeholders will not have a complete  picture of TVA’s progress toward managing its debt or its overall financial  health.
section_title: Several Factors Could Affect TVA’s Ability to Meet Its Debt Reduction Goal, and No Mechanism Is in Place to Ensure TVA Addresses Unfunded Pension Liabilities
paragraphs: Several factors could affect TVA’s ability to meet its debt reduction goal,  including regulatory pressures, changes in demand for electricity,  technological innovations, or unforeseen events. In addition, TVA aims  to eliminate its $6 billion in unfunded pension liabilities within 20 years,  according to TVA officials, but no mechanism is in place to ensure TVA  fully funds the liabilities if, for example, plan assets do not achieve  expected returns.
subsections: section_title: Factors That Could Affect TVA’s Ability to Meet Its Debt Reduction Goals
paragraphs: Several factors could affect TVA’s ability to meet its debt reduction goals,  including regulatory pressures that could require additional capital  investment, changes in demand for electricity, technological innovations,  or unforeseen events that could affect revenues or require additional  investments.
subsections: section_title: Regulatory Pressures Could Require Additional Capital Investment
paragraphs: TVA’s fossil fuel and nuclear power plants are, or potentially will be,  affected by existing and proposed environmental and other regulations,  and the implementation of these regulations may require TVA to make  additional capital investments. For example, TVA estimates it will spend  about $2 billion on environmental expenditures and compliance with  regulations from 2017 through 2023 but, according to a TVA document,  this estimate could change as additional information becomes available  and regulations change. TVA spent about $977 million to eliminate the  wet storage of coal combustion residual, commonly called coal ash, to  assist in meeting EPA and Tennessee Department of Environment and  Conservation environmental requirements. As part of these efforts, TVA  prepared a June 2016 environmental impact statement on the approach it  planned to take for closing coal ash impoundments at its coal plants,  which involved converting all its wet storage to dry storage. According to  a TVA document, the agency anticipates spending about an additional  $1.2 billion in related coal ash costs through 2022.
While the status of the Clean Power Plan that EPA issued in 2015 is  unclear, TVA continues to assess the plan and its status. According to  TVA documentation, TVA is well positioned to meet carbon emission  guidelines for existing fossil fuel plants under the plan. Specifically, in  April 2011, TVA agreed to retire 18 of its 59 fossil fuel units by the end of  2017 for several reasons, including the cost of adding emission control  equipment and other environmental improvements to the units. As of  September 2016, TVA had retired 14 of the 18 units and reported that it  would continue to evaluate the appropriate asset mix, given the costs of  continuing to operate its coal plants, including adhering to environmental  regulations.
With regard to TVA’s nuclear power plants, TVA also faces potential costs  related to proposed regulations. For example, in May 2014, NRC notified  certain nuclear power plant licensees of the results of seismic hazard  screening evaluations performed following the Fukushima nuclear  accident. Based on the screening results, TVA must conduct additional  seismic risk evaluations of all three of its nuclear plants—Browns Ferry,  Sequoyah, and Watts Bar—by 2019. According to TVA, NRC is  developing a rule anticipated in mid-2017 for nuclear plants to mitigate  the effects of events, such as seismic events, that exceed plant design  standards that could require TVA to modify one or more of its nuclear  plants. According to TVA documents, plant modification costs will be  unknown until the rule is finalized, but they could be substantial.
section_title: Changes in Electricity Demand, Technological Innovation, or Unforeseen Events Could Affect Revenues or Require Additional Investments
paragraphs: Reductions in demand for electricity could affect TVA’s revenues;  alternatively, increases in demand could generate additional revenue but  require investment in additional capacity or purchased power. The  expanded use of distributed generation and increased energy efficiency  and conservation could reduce demand for electricity in TVA’s service  area and affect its revenues. As the amount of distributed generation  grows and renewable generation and energy efficiency technologies  improve and become more cost-effective, TVA projects sales of electricity  will see little, if any, growth in upcoming years. According to several  representatives from industry and stakeholder groups, distributed  generation could increase competition from end-use customers— consumers who typically buy power from the local power companies that  obtain power from TVA—if they adopt on-site power generation.  According to EIA’s Annual Energy Outlook 2016, annual electricity  demand for the average household will decline by 11 percent from 2015  to 2040. EIA reported that factors contributing to a decline in household  demand include efficient lighting technologies and increased distributed  generation, particularly rooftop solar. According to TVA documents, the  agency cannot predict the financial impact from future growth of  distributed generation but TVA has taken steps to anticipate the changes  in the electricity market that distributed generation could bring. For  example, in 2016, TVA announced a new business unit focused on  distributed energy resources and the energy delivery marketplace, and  according to a TVA official, it also formed information exchanges to  provide forums to discuss implementation issues related to distributed  generation and energy efficiency.
Other technological developments in the electric utility industry could  change TVA’s operating costs or requirements. For example, several  representatives we interviewed from industry and stakeholder groups said  that energy storage technology could become more cost-effective and  change the way utilities operate. While the added capacity provided by  energy storage could delay or alleviate the need for TVA to build  additional power plants, TVA officials said that there are still several  unknowns about the technology though they do not believe integration of  battery storage into the system would be problematic. Finally, unforeseen  events could also affect TVA’s ability to meet debt reduction goals. For  example, the 2008 Kingston coal ash spill cost about $1.2 billion to  remediate—costs TVA is still recovering.
section_title: Market Conditions and Other Factors Could Affect TVA’s Unfunded Pension Liabilities, and No Mechanism Is in Place to Ensure Full Funding of These Liabilities
paragraphs: TVA plans to make annual contributions of $300 million to the pension  plan, or more if required by the TVARS Rules, for up to 20 years.  According to TVA’s analysis, there is a 50 percent chance that annual  contributions of $300 million could eliminate the $6 billion funding shortfall  at the end of 20 years and a 50 percent chance that a funding shortfall  would remain. TVA’s analysis assumes an annual return of 7 percent on  pension plan assets, but depending on market conditions, assets could  yield higher or lower than expected returns. According to TVA officials,  the pension plan asset performance is critical to TVA’s ability to close the  pension funding shortfall. TVA officials have stated a goal to fully fund the  pension plan within 20 years. However, if market conditions over the next  20 years are not favorable enough to fully fund the pension liabilities,  which TVA’s analysis assigns a 50 percent chance, TVA would need to  contribute more than $300 million per year to make up the difference if it  aims to eliminate the funding shortfall. Other factors that could affect  TVA’s pension liabilities include greater than expected increases in retiree  lifespans and declining bond yields.
In a 2010 report, the TVA OIG found that a combination of factors— including market conditions and TVA actions—resulted in a significant  shortfall between pension plan assets and projected liabilities. These  factors included: (1) TVA not making contributions to TVARS for 6 years,  (2) the addition of significant retirement benefits to the plan when the  funded status was better, (3) the establishment of TVARS Rules that had  the effect of enticing employees to retire, and (4) the economic downturn  in 2008 and 2009. The TVARS pension plan’s funded status decreased  from about 92 percent in 2007 to about 55 percent in 2016 (see fig. 6).
In December 2015, TVA proposed changes to the TVARS Rules to  reduce the obligations of the pension plan and commit to making  consistent contributions. The TVARS board approved amendments that  reduced TVA’s pension liabilities by about $960 million, reduced future  benefit accruals, and added a minimum contribution requirement of $300  million to the existing requirement for a period of 20 years. However, the  amended TVARS Rules do not adjust TVA’s annual contribution  requirement to ensure TVA will fully fund its pension liabilities. The  TVARS Rules require that for a period of 20 years, or until the plan is  deemed fully funded, TVA’s annual contribution equal the greater of (1) a  formula-based contribution or (2) $300 million. To the extent that a $300  million contribution proves inadequate because of plan experience, the  formula-based contribution would determine the amount TVA must  contribute each year. The formula uses a 30-year “open amortization  method,” meaning that the amortization period is reset to 30 years each  fiscal year, so the end of the amortization period (i.e., paying off the  unfunded liability) may never be achieved. A Blue Ribbon Panel  commissioned by the Society of Actuaries believes that plans’ risk  management practices and their ability to respond to changing economic  and market conditions would be enhanced through the use of  amortization periods shorter than the 30-year period commonly used  today. The panel recommended amortization periods of no more than  15 to 20 years for gains and losses. According to the panel’s 2014 report,  the panel believes that fully funding pension benefits of public employees  over their average future service reasonably aligns the cost of today’s  public services with the taxpayers who benefit from those services. In  addition, according to the American Academy of Actuaries, funding rules  should include targets based on accumulating the present value of  benefits for employees by the time they retire, and a plan to make up for  any variations in actual assets from the funding target within a defined  and reasonable time period. In the private sector, ERISA generally  requires a 7-year amortization of shortfalls for private sector single- employer pension plans.
Unlike an open amortization period, a closed, or fixed, amortization period  is generally maintained until the original unfunded liability amount is fully  repaid. Thus, a closed amortization period would be a better practice if  the goal is to fully fund pension liabilities. Table 2 compares the  amortization of $6 billion in unfunded liabilities using open and closed  amortization methods, assuming assets return 7 percent, as TVA  expects. The closed amortization method would extinguish the unfunded  liability in 30 years, whereas more than $4 billion in unfunded liability  would remain under the open amortization method (see table 2).
As we mentioned earlier, TVA assumes an annual return of 7 percent on  pension plan assets, but depending on market conditions, assets could  yield higher or lower than expected returns. If the return on investment  was lower than expected, the unfunded liabilities would be greater, and  TVA would need to contribute more than $300 million per year to make up  the difference. The open amortization period utilized by the TVARS  formula-based contribution requirement does not ensure TVA’s  contributions will adequately adjust for plan experience and does not  ensure full funding of the pension liabilities. Without a mechanism that  ensures TVA’s contributions will adequately adjust for actual plan  experience, unfunded liabilities could remain, and future ratepayers may  have to fund the pension plan even further to pay for services provided to  prior generations of ratepayers.
TVA officials told us that the agency does not plan to contribute more  than the TVARS Rules require and that it plans to continue to treat its  unfunded pension liabilities as regulatory assets, deferring pension costs  for recovery through rates in the future. However, the TVARS Rules do  not provide for fully funding pension benefits over the service of TVA  employees covered by the plan, which would align the cost of services  provided by covered employees with the rates paid by customers who  benefit from the services of covered employees. The deferral of  contributions necessary to close the funding shortfall reduces future  financial flexibility and may result in the need for rate increases during a  period of declining demand for electricity. If TVA needs to use revenue  originally targeted for debt reduction to pay for greater than estimated  pension expenses, this could interfere with TVA’s debt reduction goal and  additional rate increases may be required which could interfere with  TVA’s ability to keep rates low. Alternatively, less flexibility could lead to  pressure to reduce the pay or benefits of future TVA employees.
section_title: Conclusions
paragraphs: Since fiscal year 2013, TVA reduced its O&M costs by about 18 percent  while completing construction of the first nuclear unit to enter commercial  operation in 20 years. However, since the late 1970s, TVA’s financial  condition worsened largely as a result of delays, cost overruns, and  operational shutdowns in its nuclear program, and the agency continues  to invest in nuclear projects while deferring full recognition and funding of  pension liabilities. TVA generally aims to reduce its debt to increase its  financial flexibility over the long term to ensure sufficient room under its  debt ceiling so it can access capital for future investments to meet its  mission. However, retirement benefit and labor costs and cost overruns or  delays on nuclear capital projects could put pressure on TVA’s plan,  along with other factors including future demand for electricity or  unforeseen events.
GPRAMA requires agencies to report major management challenges that  they face and report performance information—including performance  goals, measures, milestones, and planned actions needed to resolve  them. However, TVA is not fully meeting this requirement, thereby  reducing transparency and raising questions about how it will meet its  goals of managing debt and reducing its unfunded pension liabilities.  TVA’s unfunded pension liabilities affect TVA’s financial health and  operations especially if TVA will need to fund them through rate increases  in the future. Without better documentation and communication of TVA’s  goals to reduce debt and unfunded pension liabilities in its performance  plan and report, including the strategies for achieving these goals,  congressional and other stakeholders will not have a complete picture of  TVA’s progress toward managing its debt or its overall financial health.
TVA aims to eliminate $6 billion in unfunded pension liabilities within 20  years, according to TVA officials, but factors such as market conditions  could affect TVA’s progress and no mechanism is in place to ensure the  pension plan is fully funded. The TVARS Rules do not adjust TVA’s  required contributions to ensure pension liabilities will be fully funded and  TVA plans to contribute no more than the rules require and to defer the  remaining pension liability. Without a mechanism that ensures TVA’s  contributions will adequately adjust for actual plan experience, unfunded  liabilities could remain, and future ratepayers may have to fund the  pension plan even further to pay for services provided to prior generations  of ratepayers.
section_title: Recommendations for Executive Action
paragraphs: We recommend that the Board of Directors ensure that TVA take the  following two actions: better document and communicate its goals to reduce its debt and  unfunded pension liabilities in its performance plans and reports,  including detailed strategies for achieving these goals. propose, and work with the TVARS board to adopt, funding rules  designed to ensure the plan’s full funding.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this product to TVA for comment. In its comments,  reproduced in appendix II, TVA agreed with our first recommendation and  stated that it will incorporate additional details in the next iteration of its  performance plan and report to enhance transparency. TVA neither  agreed nor disagreed with our second recommendation. However, TVA  said that it is committed to working with the TVARS Board to ensure a  fully funded system. It did not specifically state whether it would consider  proposing, and working with the TVARS Board to adopt, funding rules  designed to ensure the pension plan’s full funding. As TVA states in its  comments, it worked with the TVARS Board to implement plan  amendments that were effective October 1, 2016. TVA states that those  amendments have placed the retirement system on a path toward  achieving full funding in 20 years. We continue to believe that the action  we recommended is needed and, as discussed in the report, that the  open amortization period used in the TVARS Rules to determine TVA’s  minimum contribution requirement does not ensure TVA’s contributions  will adequately adjust for plan experience and, therefore, does not ensure  full funding of the pension liabilities. In addition, we received technical  comments, which we have incorporated as appropriate.
As agreed with your office, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to the appropriate  congressional committees, TVA’s board of directors, and other interested  parties. In addition, the report will be available at no charge on the GAO  website at http://www.gao.gov.
If you or your staff members have any questions about this report, please  contact me at (202) 512-3841 or ruscof@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff members who made major  contributions to this report are listed in appendix III.
section_title: Appendix I: Tennessee Valley Authority’s Debt and Other Selected Financial Data, Fiscal Years 2006 through 2016
paragraphs: The Tennessee Valley Authority (TVA) reports on debt using a measure  of total financing obligations that includes bonds and notes, which TVA  considers “statutory debt,” and other financing obligations which include  lease-leaseback obligations, energy prepayment obligations, debt related  to variable interest entities, and membership interests issued in  connection with a lease financing transaction. As table 3 shows, in fiscal  year 2016, TVA’s $26 billion in debt included about $24 billion in bonds  and notes and $2 billion in other financing obligations. Table 4 shows  selected data from TVA’s financial statements including revenues,  expenses, and other data. Table 5 shows TVA’s pension liabilities, assets  and funded status. Table 6 shows TVA’s regulatory assets—incurred  costs deferred for recovery through rates in the future—by major  category.
section_title: Appendix II: Comments from the Tennessee Valley Authority
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
paragraphs: Frank Rusco, (202) 512-3841 or ruscof@gao.gov.
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Michael Hix (Assistant Director),  Janice Ceperich, Philip Farah, Kirk Menard, and Joseph Silvestri made  key contributions to this report. Also contributing to this report were  Antoinette Capaccio, Cindy Gilbert, Steve Lowrey, Alison O’Neill, Karissa  Robie, Dan C. Royer, Barbara Timmerman, and Jacqueline Wade.