Eversource 2009 Annual Report Download - page 118

FS-33
The judgment applied in the election of the normal exception (and resulting accrual accounting) includes the conclusion that it is
probable at the inception of the contract and throughout its term that it will result in physical delivery of the underlying product and that
the quantities will be used or sold by the business over a reasonable period in the normal course of business. The Company has
elected normal on many derivative contracts, including all of WMECO's derivative contracts. If facts and circumstances change and
management can no longer support this conclusion, then the normal exception and accrual accounting is terminated and fair value
accounting is applied prospectively.
Most of the contracts that comprise NU Enterprises' wholesale marketing activities are derivatives, and many of NU's regulated
company contracts for the purchase or sale of energy or energy-related products are derivatives. Wholesale marketing contracts, which
are marked-to-market derivative contracts, are not considered to be held for trading purposes, and sales and purchase activity is
reported on a net basis in Fuel, purchased and net interchange power on the consolidated statements of income.
For further information regarding derivative contracts of NU, CL&P, PSNH and WMECO and their accounting, see Note 3, "Derivative
Instruments," to the consolidated financial statements.
G. Fair Value Measurements
On January 1, 2008, NU, including CL&P, PSNH, and WMECO, adopted fair value measurement guidance, which established a
framework for defining and measuring fair value and required expanded disclosures about fair value measurements.
Upon adoption, the Company applied this guidance to the regulated and unregulated companies' derivative contracts that are recorded
at fair value and to the marketable securities held in the NU supplemental benefit trust and WMECO's spent nuclear fuel trust. Fair
value measurement guidance also applies to investment valuations used to calculate the funded status of NU's Pension and PBOP
plans and non-recurring fair value measurements of NU's non-financial assets and liabilities, such as Yankee Gas goodwill and AROs.
As a result of adoption, the Company recorded a pre-tax charge to Net income of $6.1 million as of January 1, 2008 related to derivative
liabilities for its remaining unregulated wholesale marketing contracts. In 2009 and 2008, the Company recorded benefits of $0.7 million
and $0.8 million, respectively, to partially reverse the exit price impact recorded as the Company served out rather than exited the
contract with the New York Municipal Power Authority (NYMPA). In 2008, the Company also recorded a benefit of $1.8 million related
to a contract that expired in May 2008.
The Company also recorded changes in fair value of certain derivative contracts of CL&P. Because CL&P is a cost-of-service, rate-
regulated entity, the cost or benefit of the contracts is expected to be fully recovered from or refunded to CL&P's customers, and an
offsetting regulatory asset or liability was recorded to reflect these changes. Accordingly, there was no impact to Net income as a result
of these contracts.
The Company measures its derivative instruments that are not designated as normal and marketable securities at fair value.
Fair Value Hierarchy: In measuring fair value the Company uses observable market data when available and minimizes the use of
unobservable inputs. Unobservable inputs are needed to value certain derivative contracts due to complexities in terms of the
contracts. Inputs used in fair value measurements are categorized into three fair value hierarchy levels for disclosure purposes. The
entire fair value measurement is categorized based on the lowest level of input that is significant to the fair value measurement. The
three levels of the fair value hierarchy are described below:
Level 1 - Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities as of the reporting date.
Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide
pricing information on an ongoing basis.
Level 2 - Inputs are quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in
markets that are not active, and model-derived valuations in which all significant inputs are observable.
Level 3 - Quoted market prices are not available. Fair value is derived from valuation techniques in which one or more
significant inputs or assumptions are unobservable. Where possible, valuation techniques incorporate observable market
inputs that can be validated to external sources such as industry exchanges, including prices of energy and energy-related
products. Significant unobservable inputs are used in the valuations, including items such as energy and energy-related
product prices in future years for which observable prices are not yet available, future contract quantities under full-
requirements or supplemental sales contracts, and market volatilities. Items valued using these valuation techniques are
classified according to the lowest level for which there is at least one input that is significant to the valuation. Therefore, an
item may be classified in Level 3 even though there may be some significant inputs that are readily observable.
Determination of Fair Value: The valuation techniques and inputs used in NU's fair value measurements are as follows:
Derivative instruments: Many of the Company's derivative positions that are recorded at fair value are classified as Level 3 within the
fair value hierarchy and are valued using models that incorporate both observable and unobservable inputs. Fair value is modeled
using techniques such as discounted cash flow approaches adjusted for assumptions relating to exit price and the Black-Scholes option
pricing model, incorporating the terms of the contracts. Significant unobservable inputs used in the valuations include energy and
energy-related product prices for future years for long-dated derivative contracts, future contract quantities under requirements and
supplemental sales contracts, and market volatilities. Discounted cash flow valuations incorporate estimates of premiums or discounts