Pacific Gas Electric Company v. City and County of San Francisco/Opinion of the Court
Since 1905 appellant has been the sole producer and general distributor of heating and illuminating gas in the San Francisco district. By three separate ordinances passed in June of 1913, 1914, and 1915, the board of supervisors directed it to supply such gas during the fiscal year commencing July 1st thereafter at not more than 75 cents per 1,000 feet. Claiming that the rate so prescribed would not yield fair return, appellant brought suits in July, 1913, 1914, and 1915, to prevent enforcement of the respective ordinances. Restraining orders issued upon condition that monthly statements should show each consumer's account, and bond should be given to secure proper repayments, with interest. The maximum rate in the schedule thereafter maintained was 85 cents per 1,000.

December 15, 1916, the causes were consolidated and referred to a master. After taking much testimony he presented an elaborate report, March 2, 1920, which recommended dismissal of the bills and repayment of whatever had been collected above the prescribed rate. The District Court affirmed the report and directed an appropriate decree.

The master found that not less than 7 per centum net upon the value of the property devoted to public use was necessary for a fair return; also that, if observed, the prescribed rate would have yielded more than 7 per centum-for 1913-1914, an excess of $21,402.95; for 1914-1915, $89,446.12; and for 1915-1916, $171,464.48.

We think the evidence supports the finding that a net return of 7 per centum was necessary in order to avoid confiscation.

The inventory of the many items making up appellant's manufacturing and distributing plant with their reproduction cost new was agreed upon by the parties. In order to determine accrued depreciation and ascertain true values during the years 1913-1916, the master applied the 'modified sinking fund method.' Concerning this he said:

It involves 'an estimate of the lives of the different      structural units, and an annual allowance set aside from the      rates received as a reserve for future replacement on a 5 per      cent. compound interest curve, the capital basis of return to      the owner being depreciated each year in an amount exactly      corresponding with yearly additions to the reserve. It is      assumed that loss of plant units by obsolescence and      inadequacy, as well as by physical decay, can be forecast      with substantial accuracy and provided for in advance of      abandonment and replacement.'

Appellant objects to the application of this method and insists that depreciation should have been ascertained upon full consideration of the definite testimony given by competent experts who examined the structural units, spoke concerning observed conditions and made estimates therefrom. As these examinations were made subsequent to the alleged depreciation for the definite purpose of ascertaining existing facts, we think the criticism is not without merit. Facts shown by reliable evidence were preferable to averages based upon assumed probabilities. When a plant has been conducted with unusual skill, the owner may justly claim the consequent benefits. The problem was to ascertain the probable result of the specified rate, if applied under well-known past conditions, not to forecast the probable outcome of a proposed rate under unknown future conditions.

Counsel do not insist that the estimated accrued depreciation is 'grossly excessive,' if confined to the result of physical causes. But they do maintain that the master should have ascertained and stated what depreciation was due to such causes and how much followed obsolescence resulting from the introduction of certain patented inventions, and we think such a finding should have been made unless some undisclosed reason prevented. The claim is that, in order to lower cost of production, it became necessary to abandon certain valuable property under conditions not reasonably susceptible of anticipation. The material and relevant facts ought to be disclosed.

The objection to the report most seriously urged is that in his estimate of total value the master failed properly to appraise certain patent rights through which manufacturing costs had been greatly reduced; also that he failed to make proper allowances for the successful use of such rights. This objection is well taken. The following excerpts from the master's long and rather involved report disclose the contested points with the relevant facts and indicate his conclusions:

'The company contends that its plant capital, as a basis of      earnings, should suffer no deduction because of supposed      depreciation due to age, but only, if at all, by the amount      of 'deferred maintenance.' And where, as here, there have      been abandonments of large units due to obsolescence, the      loss should be reimbursed by amortization over a period of      years after, rather than before, the replacement, this      amortization being effected by dividing the economies      resulting from new machines and processes between owner and      consumer, thus allowing a partial reduction in the rate. * *      *

'Until this case it had not occurred to me that, so far as      theory is concerned, reimbursement of the owner could take      place after abandonment. It would not seem fair if it      involved a raise of rates. Physical depreciation, for      example, if an accumulation is necessary to provide for      replacement, ought to be provided beforehand from the rates      of users of the service which caused the machine to wear out.      But where replacement is made on account of obsolescence or      inadequacy and economy is effected in costs, that economy can with fairness be devoted to      reimbursement for the replacement cost, the rates remaining      unchanged. I know of no well-considered method to meet this      reimbursement after the fact. The installments would have to      include interest on the unpaid principal and capital would      thus not be depreciated for purposes of return. An estimate      of the period of amortization would not have to be made if      all economies of the new machine were devoted to the      amortization; it would work itself out. If the economies were      shared with the rate payer, as plaintiff here suggests, the      period should not extend beyond the estimated life of the new      machine; a plan which is subject to the objection on the      grounds of uncertainty common to all such estimates. * * *

'But where, as here, and as is generally the case, there is      nothing to show what, if any, consideration has been given      the question of depreciation methods by the state      authorities, or anything beyond a bare schedule of rates to      be charged, then the court must determine the proper methods      by its own independent judgment. I have tried to make it      clear that in the usual case the modified sinking fund method      would seem most applicable. Notwithstanding this, in cases      where it had not been the practice to accumulate a reserve,      and where the cost of replacements has shown itself to be a      fairly uniform amount, or a fairly uniform percentage of      income or of capital, then there is no objection in sound      reasoning, nor, as I believe, in the law as laid down, why      the court should not adopt a replacement method in      determining proper costs of production; and in such event it      would rate at replacement cost new to determine the owner's      reasonable return and include actual average replacement      requirements in the yearly costs, without reserves. Or it      might figure on a reserve for part of the plant, and a      replacement method for the balance apparently adapted to it.      Conceivably, also, the court might amortize the loss by      obsolescence after abandonment had taken place, as plaintiff urges here.      But I imagine that any court will feel the same hesitation in      so doing that I feel here, for it involves reimbursement as      to structures no longer in the inventory of units in service,      and is without precedent except where the rate-fixing body      has laid it down as a proper policy. * * *

'Mr. E. C. Jones, chief gas engineer of plaintiff, also      testified that the plant was worth cost new less only the      deferred maintenance and the amount of abandonments      immediately in prospect. He estimates the amount of this      deduction at $828,916.41 (Exhibit 43), or 6.3 per cent. of      his appraisement at $13,066,201.55 (Exhibit 3). His estimate      includes no consideration of approaching obsolescence; it      does include replacement reasonably in view, due to physical      deterioration and to ordinary inadequacy. * * *

'I have referred several times to plaintiff's contention that      obsolescence should be amortized after rather than before      abandonment of a unit of plant. Specifically applied, it is      urged that when it is seen that Martin station or other      obsolete generator has been superseded by new Jones      generators, using the improved Jones process for oil gas, the      demonstrated economies thereby effected are justly to be      devoted to reimbursing the company for the loss of capital      occasioned by the obsolescence, continuing each year until      the loss is made good, with interest. On this settled program      the new generator would, of course, be rated for return at      replacement cost new at all times. To give the consumer a      part of the advantages of the improvement, the company      proposes that only half of the very considerable economies of      operation shall be devoted to its reimbursement. Many      advantages are urged for this plan: That it throws upon the      consumer, who has the benefit of the new equipment in the      shape of reduced charges, the burden of the loss by      supersession of equipment otherwise in good condition; that it avoids the defect that      is inherent in a system of setting aside reserves in advance      of abandonment, namely, that while the life of a depreciable      unit is difficult enough to estimate when physical decay      alone is considered, it is practically impossible to forecast      when we consider that obsolescence and inadequacy, which      usually account for abandonments in a gas manufacturing      plant, follow no rules as to time of their operation; that,      finally, progress in service is promoted by giving a gas      company an incentive to improvement of its machinery and its      processes in the shape of increased profits. It must be      admitted that if replacement of an old machine has not been      sufficiently provided for by reserves in advance, a company      will naturally defer installing a new machine, and so      progress is halted. It is, furthermore, true that the      application of the usual formula, fair return on fair present      value of the plant in service, gives to the consumer all the      advantages of economies in operating costs, which plainly is      not entire justice. The city's counsel agrees (Argument, 451)      that if obsolescence had occurred suddenly, with no      opportunity to create reserves for replacement, the loss      should be amortized after abandonment; but he denies that the      facts here conform to the hypothesis. * * *

'Mr. E. C. Jones, chief gas engineer of plaintiff, and his      son, Mr. Leon B. Jones, assistant gas engineer, on an      application filed May 23, 1912, were on March 10, 1914,      granted United States Letters Patent for an improved      apparatus for manufacturing oil gas; and on October 19, 1915,      on an application also filed May 23, 1912, were granted      letters for the process. On November 30, 1915, they granted      to plaintiff the exclusive right to use the process, and to      make and use, but not to sell, the apparatus, together with      future improvements in either process or apparatus made      during the lives of the patents; the rights granted being      transferable, but restricted as to place to a number of named counties in Northern and Central      California. Despite the late date of the grant, plaintiff's      beneficial right covered the period in suit, for the prior      installation of generators embodying the Jones patents at the      Metropolitan and the Potrero stations, with the patentees'      consent, conferred an implied license to use them during      their life in the San Francisco district; but this license      was not exclusive. The contract underlying the grants      (Exhibit 61) recited that the company had permitted the      patentees to use its plant and facilities for experimentation      and commercial demonstration of their investions; had      expended in alterations in its Metropolitan plant a sum      exceeding $100,000, and also had expended in erecting two new      gas generators at the Potrero station embodying the      inventions a sum exceeding $215,000; that continued operation      of all said new or altered apparatus under the patentees'      direction had demonstrated the great utility and value of the      inventions and that they could be utilized 'to the great      pecuniary advantage' of the plaintiff company; that the      company had allowed the patentees to exhibit the apparatus to      many persons interested in gas manufacture in this country      and Europe as a demonstration of the utility and value of      their inventions, and that the patentees regarded the      privilege of future such exhibitions as of great value to      them. It was then agreed that for the grants first above      referred to the company would pay the patentees the sum of      $46,066.67, and would allow full opportunity for future      exhibition of the generators, and so forth.

'The question is at what figures these rights of the company      shall be taken into the rating base. It seems to be agreed      that the amount actually paid in 1915 is already represented      in the amount hitherto added as additions and betterments.

'The presentation of plaintiff's case in the form approved by      its counsel does not primarily involve the giving of a value to these patent rights. Counsel in argument stated      in substance that the evidence as to their value seemed to      involve such enormous sums that he preferred the more      conservative course of giving them consideration in his      conception of the proper treatment of losses by obsolescence.      It will be remembered that his argument was that no new      invention would be installed by a man of business unless its      savings were available to him to recoup losses of capital      abandoned to make way for it; that the patent monopoly would      enable him to compel a price adequate for his recoupment; and      that in a proceeding like this it was equitable to divide the      savings with the consumer and apply the company's share to      reimbursement of the loss by abandonment, meanwhile rating      the new property at value new. I have said that there was      strength of reason in this plan, but that in involved a      matter of administrative policy that was primarily for the      state's regulatory body. I have not followed this plan for      this reason and for the further reason that it appeared      obsolescence could have been foreseen and provided for, and      apparently had been provided for. This means that the      question of value of the rights must be now considered.

'The evidence is not very full on the part of plaintiff. And      due perhaps to plaintiff's position as to obsolescence, there      was little cross-examination by the city and no contrary      evidence. With oil at 68 1/2 cents a barrel to plaintiff      during the years 1912-16, Mr. Bridges estimates the savings      under the Jones process at 2 1/2 cents a thousand feet of gas      manufactured. (Exhibit 62.) In Table X of his supplemental      argument, Mr. Bosley estimates the savings shown by the      evidence at 2+ cents for the first two years and over 4 cents      for the year 1915-16, or, in sum total, $103,530.39 for      1913-14, $132,419.45 for 1914-15, and $258,557.81 for      1915-16. A just criticism of these estimates is that they      give no influence to the economies due to larger production. Mr. Britton, general      manager of plaintiff, speaking of results attained in      1916-17, testifies that the new Jones generators effected a      saving of two gallons of oil per thousand feet of gas and      over one cent a thousand in labor costs of manufacture. (Tr.      2248 seq.) Projecting the savings over the 16 remaining years      of the letters patent, he computes the aggregate savings at      $7,630,300. (Tr. 2251.) Mr. Vincent computes the present      worth on June 30, 1916, of these future savings at      $4,203,300. (Exhibit 67.) While apparently the estimates are      made on conservative bases, it is, of course, true that      forecasts like this are full of uncertainties; for example,      oil may rise to a price prohibitive for gas consumption on      the present scale, or other inventions or even substitutes for      gas may diminish the value of the Jones patent.

'There is no doubt that these patents are property, and of      great value. It is also true, I think, that justice demands      that the utility company should profit in some substantial      proportion by the economies brought about by its ability in      management or its improvements in methods of manufacture.      There is no good reason why the consumers should get all the      advantages that are the fruit of the genius of these      inventors. If by the terms of their employment Mr. Jones and      his son had been bound to assign their patents to plaintiff      without further compensation, and had done so, the city could      not justly claim that the company should have no part of the      savings effected. The patents would have to be valued. But in      view of the fact that the company and the patentees, dealing      presumably at arms' length, have reached a figure of about      $46,000 as the value of exclusive rights throughout Northern      California, I am as much embarrassed as was plaintiff's      counsel in concluding that in San Francisco alone the rights      are to be valued for purposes of return at $4,000,000 or any      substantial fraction of that sum. And how are we to compare in value the      full rights obtained by express grant in 1915 and the      restricted rights arising by implied license in the prior      years? In view of the state of the evidence, it seems to me      better to pass the whole matter for future consideration in      connection with the rates of later years, when the state      commission can pass on it with full evidence before it. On      the record before me I do not see my way clear to add any      figure to the rating base on account of these patent rights.      * * *

'Objections Nos. 8, 9 and 10 have to do with the valuation of      plaintiff's rights under the Jones patents. Plaintiff is      incorrect in stating that the master failed to find the      present value of the patent rights. These were allowed in      capital value as stated (page 85) at $46,066.67, the amount      paid the grantors in 1915. If the plaintiff had paid the      inventors, say $500,000, or other considerable sum, for these      patent rights, there is no reason to doubt that this figure      would have been accepted as the valuation for purposes of      return. It is not my view that a valuation must follow cost,      although it is more apt to do so where the purchase was      recently made. I have stated as fully as I could the reasons      why I could not find the immensely greater figure which      plaintiff claims. Briefly, the evidence was entirely too      speculative. There is, after all, in such a policy no      particular restriction to enterprise in denying to      stockholders the fruits of valuable inventions, because the      stockholders do not function in the direction of enterprise.      The way to reward enterprise is to pay large sums to      inventors, but that is not the question here. In a      supplementary argument counsel asks me to apply here the rule      which prevails in patent accountings, where, when damages      cannot be ascertained by reference to an established royalty,      the master is permitted to determine from all the evidence      what would have been a reasonable royalty. The qualification      to this rule is, however, that the master must have some evidence upon which his mind can      work and rely, and that is to a large degree lacking here,      save in so far as it is given by the amount of the purchase      price. The objections named are accordingly overruled.'

Obviously, under the theory accepted below, appellant worsened its situation for rate-making puroses when it reduced the cost of manufacturing gas. Introduction of successful patented inventions enabled the public authorities to lower the rate base and gather all the benefits. The operating plant, made capable of producing gas at smaller cost, was declared less valuable than before. The result indicates error somewhere, either in theory or application of principle.

Obsolescence of one or more stations and perhaps other property theretofore of great value (possibly $800,000) followed installation of the patents, but the remaining plant plus the patents gave better results. As an operating unit the new combination had greater value than the old; but the court below disregarded the demonstrated worth of the element which wrought this thange.

The obsolescence in question did not result from ordinary use and wear. Certainly it could not have been long anticipated-the patents were of recent conception; to provide for it out of previous revenues was not imperative, if possible. Former consumers were not beneficiaries; only subsequent ones could be advantaged.

Our concern is with confiscation. Rate making is no function of the courts; their duty is to inquire concerning results and uphold the guaranties which inhibit the taking of private property for public use without just compensation under any guise. We may not, therefore, relegate appellant's claim for past services to the future consideration of the state commission, as the master suggests. After adopting the reduced costs of manufacture for estimating net returns, the court gave no proper valuation to the inventions which caused the reduction, and thereby permitted property to be taken without just compensation. The amount of money actually paid to the inventors was not the proper measure of worth. Experience had demonstrated a much higher one; and to obtain the benefit of their use appellant sacrificed much.

Installation of the inventions necessitated new outlay of money and abandonment of property theretofore valuable-both were necessary in order that the cost of manufacture might be reduced. If appellant's permissible profits depend upon the lowered costs and it is denied adequate return upon property which made the reduction possible, or recompense for the obsolescence, successful efforts to improve the service will prove extremely disadvantageous to it.

Whether, under the peculiar circumstances here presented, the rate base should be fixed by adding to the agreed inventory some fair valuation of the patent rights, or whether prompt recoupment should be allowed for the obsolescence caused by their introduction, or whether appellant should be saved from actual ultimate loss by some other feasible method, we will not undertake to determine upon the present record. To the end that the issues may be reconsidered in view of this opinion, the decree below is reversed and the cause remanded for such further proceedings as the circumstances require, including another reference to the master if deemed advisable.

Reversed.

Mr. Justice BRANDEIS (dissenting). These cases were tried together. Each challenges as confiscatory an ordinance of the city of San Francisco fixing, for a single year, the price to be charged for gas. The rule of Smyth v. Ames, 169 U.S. 466, 18 Sup. Ct. 418, 42 L. Ed. 819, was applied. The evidence, in condensed form, comes before us in a record of 943 pages. The master's original and supplemental reports occupy 131 pages. The master and the court found the rates to be compensatory. Three errors are assigned by the company which relate to depreciation. The facts applicable to the several years differ in part; but the same questions are presented in each. It will tend to clarity to discuss these with reference to the facts of No. 34, which involves the rate for the year beginning July 1, 1913.

First. The depreciation charge allowed for that year, for the plant as a whole, was $348,853. The company does not complain that this allowance is too small, if treated as an allowance for merely physical observed depreciation. Its claim is that an improved process, which had been introduced at the San Francisco works in 1912, resulted in a saving, during the year 1913-14, of $103,530 in oil and labor; that in 1913 it had become certain that this process would later render obsolete certain parts of the plant (called stations) which were in use throughout that year; and that, for the purpose of meeting this expected loss in capital through later abandonment of stations, the savings effected by the new process should have been charged against the earnings, and credited to a special depreciation reserve. If, as suggested below, the company's contention is that only one-half of the savings should be credited to this special depreciation reserve, the action of the District Court on this ground is obviously free from objection. For, in fact, there was included in the year's depreciation charge, for obsolescence of these stations, $64,962, which is more than one-half of the year's savings. But its claim here is that the whole of the savings of the year 1913-14 should have been so applied; and that, therefore, the balance thereof, namely, $38,568, should also have been included in this special depreciation charge. 

The sum ($348,853) allowed as the depreciation charge for the year 1913-14 was nearly 3 per cent. of the then reproduction cost new of the whole plant, other than land. The master and the court found, as facts, that none of the plant was abandoned during that year; that the change in the process of manufacture was not revolutionary; that in view of the history of the art, such change or improvements, and resulting obsolescence of parts of the plants, schould have been foreseen; that, in fact, there had been accumulated, during the four years preceding 1912, as a general reserve for depreciation, the sum of $2,116,433.95; that this reserve had been charged off by the company to surplus in November, 1911; and that, but for this fact, it would have been available to meet the loss of capital which occurred later through the abandonment of stations.

This alleged error does not present any question of law. Whether more of the savings of the year 1913-14 due to the introduction of the new process should have been allowed as a special depreciation charge for the obsolescence then known to be accruing, is clearly a question of fact. There is much conflict in the theories on which depreciation should be figured.  There was doubt when the obsolescence would culminate and what would be its extent. There was conflict in the evidence as to the rate to be deemed a fair return. Whether a return of 7 per cent. is the proper test of a compensatory rate must, obviously, depend in part upon whether the return includes any of the risk of obsolescence.  I cannot say that the master and the court erred in their conclusion of fact that, all things considered, the depreciation charge allowed was adequate. The same is true of the depreciation charges allowed for the years 1914 and 1915. 

Second. As an alternative to allowing a larger depreciation charge out of the year's savings through the improved process and apparatus, the company urges that the rate base should have been increased, by adding thereto the value of the right to use the new process at the San Francisco works.  The court apparently adopted this view of the law. It ruled that the company was entitled to a return upon the then value (as part of the rate base) of the right to use the inventions. It differed from the company only in the estimate of the value. The company's experts declared that the value of this right might be ascertained by capitalizing the average annual savings expected to be effected thereby. So calculated, the value is $4,203,300. The court found specifically that it could not accept estimated savings as a measure of value; among other reasons, because the amount of savings was dependent in large measure upon the price of crude oil, and that this price fluctuates largely from time to time. It included in the rate base for 1913-14 the value of the gas generators (at the Metropolitan plant) which had been reconstructed so as to embody the inventions, and found that there was in the record no evidence on which it could give to the right to use the inventions a greater value than was allowed. So far as concerns the year 1913-14, the question is, merely, whether on the evidence in the record the value of the reconstructed generators (including, of course, the right to use them) was too small.  It appeared that for the right to use the inventions nothing was paid either during the year 1913-14 or during the year 1914-15; and that for the exclusive right to use them both in San Francisco and throughout a number of counties in Northern California, the company paid to the inventors, in November, 1915, $46,066.68. I cannot say that the master and the District Court erred in the finding of fact by which they valued this item for that year, or in the value assigned to the right in fixing the rate base for either of the two following years.  This alternative contention of the company presents, obviously, no question of law.

Third. The reproduction cost new of the manufacturing and distributing plant, other than land, was found to be $12,794,008; the accrued depreciation, $1,518,390 (as of June 30, 1914). Thus, the property was found to be worth 88.1 per cent. of its then reproduction cost. The company contends that the accrued depreciation should have been set at $828,916.41; so that the plant was worth 93.7 per cent. of its then reproduction cost. The master employed the 'compound interest' or 'modified sinking fund' method of estimating accrued depreciation. The plant is in part very old. The depreciation found is but a small percentage of the reproduction cost. The evidence bearing upon the amount to be deducted for accrued depreciation occupies 232 pages of the record. The discussion thereof in the master's report occupies 39 pages. There was a conflict of evidence.

No question of law is presented by this assignment of error.  The company's objection is not to the particular method selected, but that, in applying it, the master included as depreciation what is called theoretical inadequacy and obsolescence. Whether he did is a question of fact. The city denies that the reduction in value made by the master on account of accrued depreciation includes any sum representing expected loss through future abandonment of the stations. It is clear that, if any deduction was made on account of the probable abandonment of the stations, the obsolescence thus provided for was not theoretical. The new process had been introduced 2 years before the date as of which the valuation was made. On the facts then known, it was expected that the stations would have to be abandoned in the near future. Because it was to be expected (and was not theoretical) the company contended that to offset it more of the year's savings should have been charged against the income of that year. I cannot say that the master and the court erred in their findings of fact as to the amount of accrued depreciation.

This litigation has already extended over 11 years. The record discloses that the cases were presented below by competent counsel with the aid of competent experts, and that they received careful consideration by an able master and an able trial judge. Counsel, master, and court have throughout endeavored to apply the rule of Smyth v. Ames, 169 U.S. 466, 18 Sup. Ct. 418, 42 L. Ed. 819. It was not shown that the rule has, in any respect, been departed from. This court harbors a doubt whether, in applying it, some injustice may not have been done to the company. Is it probable that a nearer approach to justice, as between the parties, will be attained by a continuation of the effort to apply the same rule? To me it seems that the doubt is inherent in the rule itself. It can be overcome only by substituting some other rule for that found to be unworkable. Such other lies near at hand, and it is consistent with the Constitution.

It was settled by Knoxville v. Knoxville Water Co., 212 U.S. 1, 29 Sup. Ct. 148, 53 L. Ed. 371, that every public utility must, at its peril, provide an adequate amount to cover depreciation. A depreciation charge resembles a life insurance premium. The depreciation reserve, to which it is credited, supplies insurance for the plant against its inevitable decadence, as the life insurance reserve supplies the fund to meet the agreed value of the lost human life. To determine what the amount of the annual life insurance premium should be is a much simpler task than to determine the proper depreciation charge. For life insurance is a co-operative undertaking. The premium to be fixed is not that required by the probable duration of the life of a single insured individual, but that required by the average expectancy of life of men or women of the given age. Moreover, for human lives, mortality tables have been constructed which embody the results of large experience and long study. By their use the required premium may be fixed with an approximation to accuracy. But, despite the relative simplicity of the problem, it was found that the variables leave so wide a margin for error that premiums fixed in accordance with mortality tables work serious injustice either to the insurer or to the insured. Although the purpose was to charge only the appropriate premium, the transaction resulted sometimes in bankruptcy of the insurer; sometimes in his securing profits which seemed extortionate; and, rarely, in his receiving only the intended fair compensation for the service rendered. Because every attempt to approximate more nearly the amount of required premium proved futile, justice was sought by another route. Ultimately, strictly mutual insurance was adopted. Under it, the premium charged is made clearly ample, and the part thereof which proves not to have been needed inures in some form to the benefit of him who paid it. Compare Penn Mutual Life Insurance Co. v. Lederer, 252 U.S. 523, 524, 525, 40 Sup. Ct. 397, 64 L. Ed. 698.

Legal science can solve the problem of the just depreciation charge for public utilities in a similar manner. Under the rule which fixes the rate base at the amount prudently invested, the inevitable errors incident to fixing the year's depreciation charge do not result in injustice either to the utility or to the community. If, when plant must be replaced, the amount set aside for depreciation proves to have been inadequate, and investment of new capital is required, the utility is permitted to earn the annual cost of the new capital. If, on the other hand, the amount set aside for depreciation proves to have been excessive, the income from the surplus reserve operates as a credit to reduce the current capital charge which the rates must earn. If a new device is adopted which involves additional investment (to buy a new plant or a patent right) the company's investment, on which the return must be paid, is increased by that amount. If the new device does not involve new investment, but the innovation involves increased current payments (like royalties for use of a process) the additional disbursement is borne by the community as an operating expense. The cost of a scrapped plant is carried as part of the investment on which a return must be paid unless and until it has been retired, that is fully paid for, out of the depreciation reserve. Thus justice both to the owners of the utility and to the public is assured.

Mr. Justice HOLMES. I am of opinion that the decree should be affirmed on the main point for reasons that will be stated by my Brother BRANDEIS. 

Notes