How to plan for affordable, supportable utility rates

August 23, 2018 Carol Malesky

Utilities benefit from financial planning and selecting the right funding strategy—and those benefits can be passed to the customer

 

After years of double-digit rate increases, customers, boards, councils, and other decision-makers tend to lose their appetites for more. But today, many utilities face the need for more—more infrastructure replacements and improvements, more funding for projects, and more rate increases to pay for that funding.

Balancing necessary, affordable rate increases that sufficiently achieve utilities’ objectives can be done with proper planning and analysis. Planning and analysis is critical when it’s time for decision makers to make tough decisions about utility rates. Providing clear materials, rate options that meet strategic objectives, and evidence that utility bills will not comprise a significant portion of customers’ incomes (understanding that not all customers will be able to afford their bills) all help utilities’ leaders adopt rate increases they can support.

 

 

Why financial planning and master planning go hand in hand

Some utilities do not have the ability to address financial planning and rate impacts while creating a master plan for facilities. Some are subject to Consent Decrees and are required to complete a set of projects at specific times, regardless of the impact on customers. Communities frequently conduct rate studies to determine if customers are paying appropriate rates and charges for services but fail to integrate these analyses with budgeting, management, and master plan requirements. Without financial planning, utilities are not properly informed, and an inaccurate picture of affordability could be assumed.

I’ve often seen incorrect assessments of the ability to fund necessary capital projects and operational requirements to ensure long-term viability of system infrastructure. In a perfect world, financial planning would be concurrent with master planning, with feedback from each plan informing the other. Capital improvement program (CIP) projects can be scheduled according to funding availability while minimizing rate increases to customers.

Our team develops detailed financial plans that are valuable capital planning tools. We use these to review master plans and entire CIPs to evaluate the impacts of associated costs, timing, and funding sources. This evaluation works best as alternative CIPs are developed during the master planning process, but it is never too late to evaluate alternative project schedules and timing and adjust where the utility deems appropriate.

 

Our team developed a new approach to evaluate affordability called WARi (Weighted Average Residential Index), which helps in projecting affordability over time.

 

Approach to developing supportable rates

In Ohio, our team worked with the Northeast Ohio Regional Sewer District (NEORSD) which serves most of the City of Cleveland and 61 suburban communities. Its large service area comes with large needs driven by capital requirements of $5 billion over the next 30 years. The capital needs average $200 million per year and will require additional financing substantially larger than ever before. The District needs to maintain its financial status through consistent revenues by approval of new rates, which will allow it to minimize its costs of borrowing and keep rates as low as possible.

_q_tweetable:By integrating affordability into the financial planning and rate scenario process, we provided the Board a view of the impacts of future rate increases on their customers’ ability to pay sewer bills._q_The key to maintaining the District’s revenue is to provide sufficient analysis and information for regular approval of new cost-based rates. Our team helped develop strategies to mitigate and manage potential impediments to a continuous process of future rate increases. From an economic perspective, increased rates may result in a greater amount of uncollectable accounts and lost revenue. From a political perspective, support for future rate increases is at risk of shrinking as bills become less affordable for many residents. Both are impediments to the District’s sustainability goals.

A key focus of our study was to develop strategies to directly confront the issue of affordability. We developed a new approach to evaluate affordability called WARi (Weighted Average Residential Index). WARi enhances visibility of residential affordability for utility managers by focusing on three key areas that the usual approaches neglect: population details by neighborhoods, the full distribution of income unique to the community, and real bills (rather than hypothetical.)

Affordability projections were provided for each rate scenario analyzed for the Board. By integrating affordability into the financial planning and rate scenario process, we provided the Board a view of the impacts of future rate increases on their customers’ ability to pay sewer bills. More importantly, we provided the District with useful information for improving its affordability programs.

 

Planning for future success

In the end, the biggest benefits of integrating financial planning and affordability analyses into rate making are that you can clearly demonstrate: what is needed, when it is needed, how you can pay for it, and how it will affect customers’ abilities to pay utility bills.

A detailed and fully integrated financial plan linked to rate options helps us give the Board all the information it needs to approve necessary, affordable rate increases. For NEORSD, our hope is that District staff continue to use the financial plan model and that further research on expanding its affordability programs provides a means of improving affordability of sewer service for all.

 

About the Author

Carol Malesky

An economist with 20 years of experience, Carol Malesky has managed dozens of financial planning projects. From small water companies to large municipalities, she applies sound economic principles to the financial challenges facing the utility industry today.

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