Risk management is essential for small water systems to ensure the continued delivery of safe and reliable water to their communities. These systems often operate with limited resources, making them especially vulnerable to unexpected events such as equipment failures, natural disasters, or regulatory changes. By proactively identifying and addressing potential risks, small water systems can better protect their infrastructure, maintain financial stability, and build resilience against future uncertainties.
Given the uncertainty, measuring risks is challenging. GFOA developed a framework relying on both historical data and Probability Management (PM) concept to evaluate the probability and magnitude of risks. The framework ultimately helps answer the question on how much reserve should a local government, given its exposed risks, should have to maintain the desired level of performance? The case study of Goleta Water District demonstrates the application of this framework, It is worth mentioning that the approach is applicable to local governments and agencies. Therefore, regardless of the size, water districts can utilize this framework.
Goleta Water District (GWD or District) is a crucial public utility in Santa Barbara County, California that provides water services to nearly 87,000 residents through a comprehensive network of over 270 miles of pipeline. GWD manages a diversified water portfolio that includes Lake Cachuma, the Goleta Groundwater Basin, recycled water, and imported water from the State Water Project, providing approximately 16,500 acre-feet annually. The district has also been a leader in water conservation, having launched the nation’s first low-flow toilet rebate program in 1986.[1]
GFOA worked with the GWD to conduct a risk-based reserve analysis to help the District evaluate its reserve strategy more effectively. First, GFOA consulted with the District’s staff to identify the critical risks factors confronting the District. These risks include:
- Revenue loss from droughts due to stage restrictions.
- Large-scale unanticipated infrastructure failures.
- Wildfires.
- Earthquakes.
- The cost of new regulations (e.g., new water treatment standards).
GFOA then calculated the probability of each risk occurring within a ten-year period and assessed the potential magnitude of loss for their reserve if such an event were to occur. To calculate the probability and magnitude of events, GFOA analyzed the Goleta Water District’s own experience and the experiences of regional water districts, reviewed research produced by other water agencies, and drew from the expertise of staff.
From there, the risks were each analyzed individually and then combined into a ten-year model of the District’s fund balance and reserves. GFOA’s risk model utilizes the Monte Carlo methodology to perform ten thousand simulations of possible future scenarios for each identified risk. Some critical elements in the model include:
- Probability of an undesirable event.
- Magnitude of an undesirable event.
- Adjustment of rates.
- Cutting some spending to help offset the impact of reduced revenue.
- A tough time generating budget surpluses in years when revenue is reduced due to lower water sales associated with drought restrictions.
- Critical threshold.
- Starting fund balance and reserve.
The model is intended to answer the primary question: what amount of reserves will give the District confidence that it will be able to cover the losses from the risks analyzed and maintain a reserve that meets or exceeds rating agency expectations at the same time?
Table 1.1 presents the analysis, detailing the financial requirements for the District over a ten-year period to achieve the performance goal of attaining a AA- rating. The table shows a “floor” and “ceiling” amount based on how confident the District would like to be in staying above the threshold. The floor is set at 80% confidence, and the ceiling is set at 90% confidence. The table also shows the required reserve amounts as dollar amounts and percentage of total expenditures. The model suggests a range between $41.8 million and $50.6 million, equating to 73% to 89% of the District’s total expenditures. This projection provides the District with an 80% to 90% confidence level in maintaining reserve amounts consistent with a AA rating.
It is crucial to recognize that each water district might wish to use reserves for purposes other than mitigating risks – for example, building a capital project using cash financing, as well as considering the opportunity costs of holding reserves.
GFOA’s analysis focuses primarily on risk retention, or using reserves, to manage risk. However, the analysis also encourages organizations to think about how other risk management methods might alleviate the need to hold larger reserves.
It is important to note that this analysis has its limits. It is impossible for any risk analysis to be completely comprehensive of all considerations facing your water district.However, this risk-based reserve approach can hold advantages for your organization’s reserve strategy moving forward.
[1] See Goleta Water District newsletter and press portal
[2] Source: Goleta Water District