Read the previous blog, Rate Analysis for Your Water or Wastewater Utility, to learn more about what components of your rate structure should be reviewed annually by your system.
If you are running a small water or wastewater system, annually reviewing your rate structure and budget are integral components of administering an effective utility. Upon review, if your system needs to adjust rates to address rising costs due to new expenses, repairs, salary or staffing increases, inflation, or long-term planning for infrastructure replacement, the steps involved with changing your rates can be complicated. Your water system should consider affordability factors, address fixed and variable costs, and ultimately review various scenarios to adjust rates equitably. It should also inform the public of its intentions and must pass the updated rate structure at an open board meeting that allows feedback and conversation from customers.
It is important to remember that there is no perfect rate structure for a utility or one right rate structure that all should use. The correct amount of revenue can be generated multiple ways through varying rate structures so a utility must weigh many factors, including its goals and priorities, when setting its rate structure. Additionally, setting a new rate should be done collectively within the utility and involve staff from all sectors to ensure that revenue needs are considered. The chosen rate structure should be discussed with those who will be most impacted by the increase in order to build trust and understanding. When presented, it should be done earlier in the process, in a way that invites input rather than being shown as a final result. Deciding how to prioritize system needs is discussed in the prior blog and should be referenced when considering the information below.
Complete a Rate Analysis
If your system doesn’t know where to start but knows its rates are out of date, completing a rate analysis is the ideal first step, particularly if historic financial, water consumption and billing data are available. See the prior blog post in this series to learn more about how to complete this analysis, which may require assistance from a technical assistance provider like those in the Environmental Finance Center Network (EFCN).
Consider Affordability
When determining how to update—and typically raise—drinking water or wastewater rates, a utility has many priorities to consider. One is affordability, or the ability of customers to pay based on their entire set of expenses. Often, water systems are concerned that a rate increase will put an undue burden on customers that rely on fixed incomes or qualify for assistance. And while the Environmental Protection Agency (EPA) considers thresholds of either 3 or 4.5 percent of a community’s median household income appropriate for total drinking water and wastewater utility charges, water systems may not be able to guarantee average charges to remain below those figures, particularly if facing additional challenges such as increased regulatory requirements, a dwindling customer base, and increased costs due to inflation.
To combat affordability issues, a water system can look at scenarios with different types of rate structures to determine how lower income customers might be affected. For example, if usage patterns show that customers in this economic stratum use less than 3,000 gallons per month typically, the rate design may include a consumption allowance of 3,000 gallons in the base bill so that customers can budget for a set amount of expense every month. Alternatively, if lower income customers use more water on average because multiple generations are living together or there are larger household sizes in general in this category, setting block rates that escalate after that amount of usage may be beneficial. It is best to examine several options, review the impacts to various customer classes, and choose a rate structure that best addresses the needs of the system and affordability concerns.
Evaluate Fixed and Variable Costs
Another option for utilities to consider is to review expenses and determine which are fixed and which are variable. Fixed expenses such as salaries, sampling costs, building leases, taxes, insurance, and loan repayments, must be fully accounted for no matter how much water is used by customers. In contrast, variable expenses change based on the amount of water produced. These expenses include chemicals for treatment and energy to run equipment.
To encourage revenue stability a utility would use base charges to pay for fixed expenses, while volumetric charges would be used to pay for variable expenses. However, this often means a high base charge because most costs are fixed. The high base bill may be an affordability concern for low-income customers. Finding a balance between full coverage of fixed expenses through base charges and some volumetric fees while still addressing revenue stability needs and affordability concerns is possible but likely requires additional analysis.
Run Various Scenarios
When a water system needs to increase its revenues but wants to hold true to its stated financial goals, looking at a variety of options for rate increases is encouraged. The EFCN’s Water and Wastewater Rates Analysis Tool allows a water system to compare its current rates with proposed increases, and multiple comparisons can be incorporated in order to consider how best to ensure full cost recovery. Assistance from a technical assistance provider can also help decision-makers determine what to focus on during a rate increase, as well as explaining the full scope of potential alternatives, including a variety of block rates, rate classes, and different variable and fixed charges. Ultimately, the utility should ensure full cost recovery of anticipated expenses while also saving for the future through appropriate reserve accounts.
For systems concerned about how a dramatic increase in rates may create a hardship for customers, incorporating incremental rate increases over time is another potential method to increase rates. This methodology may cause short-term issues as the revenue is ramping up, but over time, the revenues will better match the necessary expenses. Going forward, systems should adjust rates incrementally each year; customers may find small annual rate increases more palatable than significant jumps sporadically. Some utilities also set multiple years of graduated rate increases all at once, rather than determining the amount each year (e.g., 5% increase per year for the next 5 years.) This approach still allows a system to plan for the future but enables increases to proceed efficiently, without having to complete all the steps over again.
Inform the Public
Once utility leadership has determined a potential solution for changing the drinking water or wastewater utility’s rate structure, the proposed rate change should be publicly discussed. In some states, this is legally mandated for a public utility; it is a best practice regardless of statutory requirement.
The purpose of a public hearing related to rate increases is simple. It allows all customers to consider how the new rate increases may affect their household finances and understand the reasons for the required changes. Having an open meeting allows citizen participation and ownership in the process, as well as allowing a chance for the system to describe/explain why it chose the rate structure and frame the narrative around the change. While customers may not like the proposed structure, they may be more willing to accept the change knowing the rationale behind it, as well as the fact that their voice has been heard.
Conclusion
Changing a water or wastewater utility’s rates—particularly increasing them—is a complex process that requires balancing competing priorities and public affordability needs. It also is necessary to raise rates over time, no matter how thrifty a community may be; inflation dictates that all other costs will likewise increase. By considering affordability, the breakdown between fixed and variable expenses, considered a variety of different rate structure scenarios, and incorporating public feedback, a utility can feel confident that it has done its due diligence to find the most appropriate way to charge customers while ensuring the long-term stability and sustainability of the utility.