Prudent Investment Rule

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In the utilities industry, the Prudent Investment Rule refers to a series of state standards which determine the fiscal soundness of a utility in the course of rate recovery for recoverable capital costs to be determined by that state’s Public Service Commission (PSC). The determination is established through a series of filings from the utility to the PSC and hearings conducted by the PSC. This occurs during a prudency hearing.^[1] The PSC follows these standards to determine if the capital costs were a "prudent investment".^[2] To determine the prudency of the investment, the PSC applies the prudent investment test or standard, determining if the costs were reasonable at the time they were incurred, and given the circumstances and what was known or knowable at the time, are to be included in the firm's rates.^[3] It is commonly used as an oversight tool by the government to ensure that money invested into a project is being spent as it was intended so the utility may recoup some costs in construction through a recovery in rates, hence the title prudent investment rule.^[4] Regulators can consider cases of hidden imprudence, but are required to consider what was known or knowable at the time the decision was made by the PSC.^[5]

The term Prudent Investment Rule, and the associated standards, have been established through a series of legal precedents. The first case to set precedent was the United States Supreme Court case of Munn v. Illinois in 1877, which allowed states to have a say in rates.^[6] Once the nature of recoverable capital costs was defined, a second question remained as to the rate at which that capital could be recovered. This issue was reasonably addressed in 1935 in Bluefield Water Works & Improvement Co. v. Public Service Commission of West Virginia, when the court said that a public utility is entitled to such rates as will permit it to earn a return equal to that generally being made at the same time and in the same general part of the country on investments in other business undertakings which are attended by corresponding risks and uncertainties.^[7]