Back to Basics – A Review of Rate Study & Rate Design

There are many potential objectives for your community to complete a Rate Study. The most basic reason is to maintain financial viability for your system now and into the future. The information developed throughout the study analysis and from financial modeling tools developed for the study can be used both to help guide long-term strategic planning, and to assist in determining rate changes in the near term. A Rate Study can form the basis for all utility financial discussions, such as planning for specific capital projects, funding annual capital renewal programs, developing/maintaining reserve accounts, determining rate adjustments, and ensuring “fair and equitable” rates for utility customers.

What makes up a Rate Study?

The term “Rate Study” is generally used to refer to a number of unique components, including:

  • Rate Design
  • Cost of Service Analysis (COSA)
  • Revenue Adequacy Evaluation

Depending upon the objectives of your Rate Study and the composition of your utility users, addressing all three of the components listed above may or may not be appropriate. Whether a Rate Study involves one or all three of these components, it should result in the creation of customized tools that your system can continue using for a period of five to ten years.

Rate Design

The basic objectives of Rate Design are to develop a system of charges that is “fair and equitable,” not unduly discriminatory, and that will provide adequate revenue to meet utility financial objectives. The primary goals of Rate Design are to develop a structure that is:

  • Easy to understand and administer.
  • Effective in yielding total revenue requirements.
  • Able to generate a stable revenue stream.
  • Structured to charge the appropriate customers based on level of service.
  • Fair and equitable, as well as defendable.
  • Tailored to achieve objectives of the utility.

In addition, there may be other goals specific to your utility, such as economic development, rate relief for fixed income users, asset management/capital renewal planning, or water conservation to name a few. You should review the basis for your existing rate design, and determine whether the structure in place is still appropriate. Think about the similarity or dissimilarity of water use or wastewater discharge patterns of your user classes. If there are no good reasons to charge one user differently than another, then a simple rate structure that applies to all classes is appropriate. However, if there are marked differences in the level of effort and/or cost to provide service to different user classes, then evaluation of a multi-level rate structure is probably warranted.

Rate Design activities can be as simple as calculating an across-the-board increase needed to meet the identified revenue requirements, or as complicated as evaluating how to apply the increase to the fixed and variable components of the rate structure for multiple user classes. If you elect to do a COSA, the results of that analysis will provide improved understanding regarding the equitability of your current rate structure. The existing rate structure should be reviewed for potential changes that could correct existing inequities and better align the rate structure with the goals of the utility. It is recommended that improvements to rate structures be implemented gradually to allow constant evaluation and ensure continued revenue stability.

Should I Complete Rate Design?

Does your current rate structure meet your objectives? If you want to promote conservation, does it send a price signal to motivate customers to reduce water use? Does it provide adequate revenue stability, even under conditions of reduced water demand? Is it easy to administer and is it perceived as fair? If you completed a COSA and there are significant disparities between cost percent and revenue percent for some user classes, then you should probably explore alternative rate design options. Before making changes, however, be sure to comprehensively review the desired objectives, so that concepts such as lifeline (minimum) rates, conservation, potential economic incentives, responsible annual reinvestment in the utilities, etc., are considered. If your current rate structure is viewed as fair and equitable and supports both near-term and long-term objectives, rate changes within the existing structure is likely the most appropriate strategy.

Whether your utility is in need of a comprehensive financial evaluation or interested only in accomplishing a very specific financial objective, a customized Rate Study tailored to your unique objectives will help accomplish your goals. A Rate Study is a powerful tool to help guide proactive, responsible decision-making for your utilities. For more information on Rate Study or Rate Design, contact Miranda Kleven or 701-746-8087.