Notes (continued) Net periodic benefit costs for the pension and other postretirement plans for the years ending December 31, 2001, 2000 and 1999 included the following components: Postretirement benefit expense recorded in 2001, 2000, and 1999 was $885,000, $781,000, and $1,064,000, respectively. $4,186,000, which is recoverable through future customer rates, is recorded as a regu- latory asset. The Company intends to make annual contributions to the plan up to the amount deductible for tax purposes. For 2001 measurement purposes, the Company assumed an 8% annual rate of increase in the per capita cost of covered benefits with the rate decreasing 1% per year to a long-term annual rate of 5% per year after three years. The health care cost trend rate assumption has a significant effect on the amounts reported. A one- percentage point change in assumed health care cost trends is estimated to have the following effect: At the Company’s 2000 annual meeting, stockholders approved a Long-Term Incentive Plan that allows grant- ing of nonqualified stock options, performance shares and dividend units. Under the plan, a total of 1,500,000 common shares are authorized for option grants. Options are granted at an exercise price that is not less than the per share common stock market price on the date of grant. The options vest at a 25% rate on their anniver- sary date over their first four years and are exercisable over a ten-year period. At December 31, 2001, 11,875 options were vested. Certain key Dominguez executives participated in the Dominguez 1997 Stock Incentive Plan that was terminated at the time Dominguez merged with the Company. The plan provided that in the event of a merger of Dominguez into another entity, granted but unexercised stock options issued became exercisable. Prior to the Merger, all outstanding Dominguez options were exercised and converted into Dominguez shares, and subse- quently converted to 52,357 shares of Company common stock. Under SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company elected to apply the provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, no compensation cost has been recognized in the consolidated financial statements for stock options that have been granted. If the Company had elected to adopt the optional recognition provisions of SFAS No. 123 for its stock option plans, basic and diluted earnings per share would be unchanged from the amounts reported, except for 2000 diluted earnings per share which was reported as $1.31, but on a pro forma basis would be $1.30. Net income for the years ended December 31, 2001, 2000 and 1999 would be as presented in the following table: The fair value of stock options used to compute pro forma net income and earnings per share disclo- sures is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following assumptions: The following table summarizes the activity for the stock option plans: For those financial instruments for which it is practicable to estimate a fair value, the following methods and assumptions were used. For cash equivalents, the carrying amount approximates fair value because of the short-term maturity of the instruments. The fair value of the Company’s long-term debt including current installments is estimated at $214,046,000 as of December 31, 2001, and $199,890,000 as of December 31, 2000, using a discounted cash flow analysis, based on the current rates available to the Company for debt of similar maturities. The fair value of advances for construction contracts is estimated at $32,000,000 as of December 31, 2001 and $27,000,000 as of December 31, 2000, based on data provided by brokers. 41 CALIFORNIA WATER SERVICE GROUP NOTE 12. FAIR VALUE OF FINANCIAL INSTRUMENTS NOTE 11. STOCK-BASED COMPENSATION PLANS Pension Benefits Other Benefits In thousands 2001 2000 1999 2001 2000 1999 Service cost $2,786 $2,846 $2,899 $ 625 $ 544 $ 498 Interest cost 4,333 4,079 3,894 858 790 689 Expected return on plan assets (4,946) (4,498) (4,450) (212) (152) (144) Net amortization and deferral 855 486 871 363 357 401 Net periodic benefit cost $3,028 $2,913 $3,214 $1,634 $1,539 $1,444 In thousands Increase Decrease Effect on total service and interest costs $ 278 $ (220) Effect on accumulated postretirement benefit obligation 2,350 (1,904) In thousands 2001 2000 1999 As reported $14,965 $19,963 $21,971 Pro forma 14,898 19,939 21,937 2001 2000 1999 Expected dividend 4.3% 4.3% 4.3% Expected volatility 30.4% 22.0% 22.6% Risk-free interest rate 4.6% 4.9% 6.2% Expected holding period in years 5.0 5.0 10.0 Weighted Weighted Weighted Average Average Average Exercise Remaining Options Fair Shares Price Contractual Life Exercisable Value Outstanding at December 31, 1998 56,221 $23.38 — 8,901 — Exercised (3,864) 22.54 Outstanding at December 31, 1999 52,357 23.45 — 19,092 — Granted 53,500 23.06 $3.74 Exercised (52,357) 23.45 Outstanding at December 31, 2000 53,500 23.06 9.5 — — Granted 58,000 25.94 5.65 Cancelled (12,000) 24.50 Outstanding at December 31, 2001 99,500 24.57 8.8 11,875 — 40 CALIFORNIA WATER SERVICE GROUP