Rate Reviews & Long-Term Financial Planning: Lessons from COVID-19

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This article was originally written for Water Finance and Management.

With the multitude of challenges the world has faced in 2020, primarily due to the COVID-19 pandemic and its economic impact, many water utilities are rethinking their approach to rate reviews and long-term financial planning. As both residential and CII customers look for rate relief and/or payment deferrals, utilities are adjusting to both temporary and potentially permanent revenue losses, looking for alternative revenue sources, and updating cash reserve policies in an attempt to both address the current situation and better prepare for a similar crisis in the future.

Even during times of economic stability, water rate reviews are time-consuming, difficult and often expensive for water utilities. The result is that they tend to either hire consultants to do rate reviews infrequently or they do more regular in-house reviews that lack depth. Some water service providers avoid rate reviews altogether. Either way, they’re left woefully unprepared for the revenue uncertainty caused by a situation like the one we currently face.

If that uncertainty has made one thing abundantly clear, it’s that the financial health of a utility depends on regular rate reviews that are a built-in component of a sound, long-term financial plan — one that addresses both the needs of today and the potential for emergency needs in the future.

The Rate Review is Not a One-Time Occurrence

A best-practice approach is to perform a rate review annually, based on your fiscal year, making the process both easier and more cost-efficient. But more importantly, doing a review every year also produces far better results. You’ll be making small, annual course corrections rather than a one-time rate overhaul, one that can be painful for both you and your customers.

But that isn’t what typically happens. Water service providers usually take one of the following approaches to rate reviews:

Hiring Consultants

Some utilities avoid the expense of consultants by bringing their rate reviews in-house. This approach normally involves analyzing data using complicated and cumbersome Excel spreadsheets that are difficult to work with, and that can sometimes break, meaning formulas get overwritten and links expire.

This approach allows you to do reviews at your own pace, which on the positive side can mean yearly reviews and rate updates. But despite the advantages of lower cost and improved frequency over consultants, an in-house review often lacks depth and is time consuming. Utilities rarely invest enough effort to do a meaningful review that accurately reflects a true picture of current and future costs and revenue needs.

Cost of Living Rate Increases

Some utilities try to make things easier by adjusting water rates annually based solely on cost of living increases, either by linking increases to the Consumer Price Index or arbitrarily choosing a percentage. While the ease of this approach can make it appealing, the fact remains that it is unlikely to reflect your actual costs.

Do Nothing

As shocking as it may seem, some utilities literally do nothing. No rate reviews and no rate changes. Sometimes we see this go on for many years or even decades. The easiest of all, this approach is also a major contributing factor to the growing infrastructure deficit currently facing so many communities in North America.

A Viable Alternative

Now consider an alternative approach that incorporates an annual rate review into your existing fiscal year. A yearly financial cycle typically looks something like this:

By integrating a more comprehensive water rate review within that process every year, usually within the budgeting phase, efficient rate updates become baked into your regular cycle. Those updates should be based on an evolving, long-term roadmap that starts with an in-depth analysis — an analysis you can do yourself, with the right tools. And by integrating annual updates into your process, your data no longer remains static and will be kept up-to-date.

The details of your specific roadmap will depend on your organization’s priorities — your goals and objectives. Once you’ve defined your objectives, you’ll have a much easier time establishing a long-term financial model, one that can be adjusted as circumstances and priorities change.

Long-Term Financial Model

Putting rate reviews on a predictable schedule makes them both more manageable and more efficient. You, your staff, your board or council, and your customers will all come to know exactly what to expect.

And because your annual reviews and your long-term plan are easily adjusted based on changing circumstances, you’ll be able to avoid both budget shortfalls and shocking surprises, such as those caused by an unanticipated infrastructure failure, an unusual weather event, or even a global pandemic.

You’ll also free up capacity for special projects, such as:

Asset replacement scheduling;
Cash reserve planning;
Rate structure review, or;
Cost of service analysis.

You’ll be able to plan for these projects over your multi-year roadmap, moving things forward or back as priorities and circumstances change, which will introduce an iterative process of continuous improvement. You’ll also be in a much better position when seeking funding, whether in the form of grants or loans.

The Importance of a Long-Term Financial Model in Securing Funding

When looking to secure grant or loan funding, creating a long-term financial model (LTFM) is essential. It will:

Demonstrate prudence and long-term thinking;
Clearly communicate your utility’s financial circumstance;
Reassure the lender/grant issuer that you will be able to meet your debt servicing obligations;

Reassure the lender/grant issuer that you will not be back to reapply once you’ve used up the funds, because your LTFM will demonstrate how the funds address your long-term needs.

An LTFM creates a road map that identifies future issues and challenges, risks and opportunities, including identifying the potential for revenue shortfalls that can cause financial instability. This allows you to better prepare by taking action now to prevent those shortfalls down the road.

The LTFM is also important in short-term financial planning, improving both efficiency and effectiveness in the budget cycle. It does this through the development of:

Policies and strategies that will best support the achievement of community goals and priorities, leading to long-term financial sustainability;
Long-term financial forecasts, including the identification of key revenue and expenditure drivers;
A common understanding among stakeholders of the utility’s financial challenges and opportunities, and consensus on the direction to be taken.

To maintain the financial safekeeping of your community’s water system, it’s important to adopt longer-term considerations into your decision making today. This is true at all times but crisis situations like the current pandemic drive that truth home. And even though you may be struggling right now, it’s never too late to start.

Finally, long-term financial forecasting is not only helpful when applying for loans and grants, it’s what you should be doing as a prudent financial steward of your community’s water system. A clear understanding of your system’s current and future revenue needs, and being able to clearly articulate those needs, will give you a solid foundation from which to reach your long-term goals, as well as help you prepare for any unforeseen circumstances that may surprise you down the road.

Primary Loans and Grants

USDA Rural Development Water & Waste Disposal Loan & Grant Program

This USDA program provides long-term, low-interest loans to help fund clean and reliable drinking water systems, and sewage and wastewater disposal. A grant may be combined with a loan if funds are available.

Eligibility is limited to rural areas and towns serving 10,000 residents or fewer, and the program requires that projects are financially sustainable. Demonstrating financial sustainability can be challenging but Waterworth can help.

EPA Drinking Water State Revolving Fund (DWSRF)

The DWSRF is a financial assistance program to help water systems and states to achieve the health protection objectives of the Safe Drinking Water Act. Congress appropriates funding for the DWSRF. The EPA then awards capitalization grants to each state for their DWSRFs each year, based on the Drinking Water Infrastructure Needs Survey and Assessment, performed every 4 years. Each state provides 20 percent in matching funds.

Utilities apply for low-interest loans through their state DWSRF, with terms up to 30 years, or the useful life of the project, whichever is less. Repayment begins up to 18 months after project completion. Repayments and interest flow back into the dedicated revolving fund, which can then be used to make additional loans over time.