What type of rate study does my community need?
John F. Damico, President, and Al C. Damico, Vice President, Environmental Rate Consultants, Inc., Union, Kentucky
There have been several manuals, handbooks and articles written on the subject of "how to" or "why to" perform a water, wastewater or stormwater utility rate study. The "how to" publications typically provide generally accepted practices, principles and procedures that are suggested to be followed by rate-setting professionals within the respective industries. The "why to" publications have been geared toward examples of utility programs that require funding for large capital outlays for expansion and upgrading, or operation and maintenance of the plant and system infrastructure. Generally, a community or district will have specific needs and requirements and feel the need for a rate study, but they may not fully understand what "kind" or what "type" of rate study will meet or satisfy their particular needs. This article presents the "what type" of rate study a community or district may need, and depending on their circumstances, how detailed and "how often" the rate study should be updated by a community or district once a study has been completed.
Community or district staff must understand how to initially prepare for the rate study by determining the reason(s) or need(s) for the rate study and identifying the least expensive but appropriate level of detailed rate study that will meet their needs. Staff can determine the most suitable rate study for their particular set of circumstances by developing answers to the following questions:
Why does my community or district need a rate study?
When does my community or district need to consider a rate study?
How in-depth does my rate study need to be?
What type of rate study is right for my community or district?
II. Why does my community or district need a rate study?
To determine "why" a community or district needs a rate study, a cursory evaluation of the overall utility should be performed. It really depends on what factors or issues the utility may be facing at that time, and what the utility may be trying to accomplish as a service provider. For example, if the utility is trying to meet an increase in growth demands, a simple and inexpensive "revenue requirements" analysis probably would be appropriate.
III. When does my community or district need to consider a rate study?
To determine "when" a community or district needs a rate study depends on what the utility is trying to accomplish on both the short- and long-term basis. Rates and revenues should be reviewed and evaluated every year as part of the overall annual budgetary process. In addition, the rule of thumb in the water resource industry is that a detailed analysis should be performed on at least a five-year cycle. In order to accomplish this, a flexible user-friendly computerized rate model is needed that will allow for frequent updates and that can be easily applied to and used for "what if" scenarios. By doing so, a community or district will always be ahead of any anticipated revenue shortcoming.
IV. How in-depth does my rate study need to be?
To determine how detailed or in-depth a community's or district's rate study should be depends on what specific situation, issues or circumstances they are facing. As an example, issues such as large user contesting their fee, or a large user believing they are paying more than their fair share, or a bulk user believing they are being unjustly overcharged, require the study to be in greater detail than simply performing a revenue requirements analysis. This is due to the potential litigation surrounding the rates and rate structure. Different circumstances will determine the amount of detail and level of effort required from the rate study.
V. What type of rate study is right for my community or district?
Determining factors such as increased growth, plant/infrastructure expansion, regulatory requirements, emergency response issues, disaster recovery, potential litigation or major capital improvements requirements will dictate the type of rate study required. To better understand this process, the general steps involved in performing a rate study are as follows:
1. Billing and collection information analysis. The analysis of the billing and collection information is performed to identify customer trends and the ever-changing rate base. The analysis determines if each customer and customer class are paying their fair share of the overall expenses of the utility service.
2. Determine revenue requirements. The revenue requirements analysis is the simplest of rate studies and is typically performed to assure the recovery of all expenditures associated with providing utility services such as administration, billing, customer service, operation and maintenance, transmission, distribution, treatment, collection, and capital improvements.
3. Perform a cost of service analysis. The cost of service analysis is performed to determine the service requirements of each customer and customer class. This analysis is based on the concept that total revenue collected should equal the total cost of services, which allows the utility to operate in a self-sustaining manner.
4. Evaluate the overall rate structure. The analysis of the overall rate structure is performed to determine the most fair and equitable rate structure possible and to eliminate any inequities inherent in the current rates and rate design. This analysis is based on the concept of documenting changes in usage, and it will ultimately determine any subsidies or inequities inherent in the overall rate structure.
5. Miscellaneous fee analysis. All miscellaneous fees and charges should be reviewed as part of an overall rate study analysis. Tap fees, turn on/turn off fees, etc. will subsidize the overall revenue base and may actually postpone a needed rate increase if these fees are updated and are calculated to recover full costs.
VI. Matching the type of rate study with community or district specific needs
Generally, a community or district will need one of three types of rate studies depending on their circumstances. The rate study types are incremental in the extent of the analysis builds as the complexity of the study increases.
1. Revenue Requirements. A Revenue Requirements rate study is the simplest, least expensive and should be the most often performed rate study type. A Revenue Requirements Analysis should be performed annually as part of the annual budgetary process. This rate study type simply proves that current revenues will meet or exceed the level of current expenditures.
When a community or district has not experienced or does not foresee any significant changes in the customer base, or if the community or district is simply attempting to assure changes in growth will not affect the revenues and expenditures, the Revenue Requirements Analysis is recommended.
2. Cost of Service and Billing Database Analysis. A Cost of Service and Billing Database Analysis is the mid-range rate study type. This rate study type includes the Revenue Requirements Analysis, and it is recommended at least once every five years.
When a community or district has experienced or has forecasted significant changes in the customer base, or if the community or district is considering adding a large bulk user such as an entire new community into the service area, a Cost of Service and Billing Database Analysis is recommended. This rate study type is performed in much greater detail, and includes analysis of revenues, expenditures and any miscellaneous charges. This analysis provides a greater understanding of "why" the revenues and expenditures are what they are. This rate study type also will determine the service requirements for each customer and customer class from differing geographic areas or differing customer requirements. This analysis is based on the concept that total revenue collected should equal the total cost of services provided and allows the utility to operate in a self-sustaining manner.
3. Rate Structure Analysis and Design. A Rate Structure Analysis and Design is the high-end range rate study type. This rate study type includes the Revenue Requirement Analysis and the Cost of Service and Billing Database Analysis. This should be performed on an "as needed" basis.
When a community or district anticipates potential litigation from a bulk user or from a very large user claiming they are paying more than their fair share of the costs of operating the utility, or when a community or district is preparing to sell a revenue bond package to fund major capital improvements, the Rate Structure Analysis and Design is recommended.
Once a community or district understands how to prepare for, select the type, and implements regular periodic rate studies, staff and decision-makers are provided with current information about future needs. Regular reviews will act as an "advance warning system" that identifies potential financial problems and provides decision-makers with sufficient time to plan and take corrective action. Therefore, decisions can be made regarding potential future events, situations, and circumstances. Depending on a community's or district's current circumstances, a determination can be made regarding what "kind" or what "type" of rate study will meet or satisfy their particular needs in a cost-effective manner.
John F. Damico can be reached at (859) 384-7283 or at firstname.lastname@example.org; Al C. Damico can be reached at (859) 384-7283 or at email@example.com. Bud Curtis, Senior Engineering Manager, Parsons Brinckerhoff Quade & Douglas, Inc., Norfolk, Virginia, and past APWA Water Resources Management Committee Chair, contributed to this article.