Rate setting for water, sewer and other utilities is a mystery to many people. It drives others crazy! Rate increases make some people so angry that the word “angry” doesn't begin to describe how they feel. “Bad” rate setting gets some local government elected officials voted out of office. No rate setting – leaving rates where they have been for years – has set thousands of utilities up for some serious hard times or even failure.

Rate setting works best when done in four phases:

Phase 1 – Decide your rate and fee goals – your destination.

Phase 2 – Develop a comprehensive rate analysis – your road map – that leads to your goals, usually requiring large initial rate adjustments and rate structure changes.

Phase 3 – Adjust rates and fees – get started on your journey – using the analysis to inform your decisions.

Phase 4 – Make incremental rate adjustments in future years – course corrections that are almost always increases – to keep net revenues and other financial indicators on track with the projections from the comprehensive rate analysis.

Utilities range in size and complexity but all need to do rate setting through these four phases. To be clear, all systems need to do Phases 1, 3 and 4 themselves. You can get advice on these phases but do-it-yourself is the only choice for getting them done. For the Phase 2 comprehensive rate analysis, you get to decide if you will do your own or if you will hire it done. However you get it done, just make sure this analysis is a good one because for a long time you will be basing everything you do on it.

Rate Setting by the Numbers

Phase 1 – Set Goals

Choosing ‘great rates' is usually a no-brainer for the author. (There are actually circumstances when you DON'T want great rates, but that is another, very special story.) Making the great rates decision is not that easy for communities. Many decisions you make about other things will impact your rates. And, decisions that you make about your rates will impact many things. It's a Rubik's cube, a giant brain teaser. If you want to have ‘great rates,' you have to solve this puzzle and set goals first. While that is easy to say, it may take many months for you to objectively arrive at rate and utility system goals.

Phase 2 – Analyze Rates

A comprehensive rate analysis mathematically solves three questions:

•  Where are we?

•  Where do we want to be?

•  How do we get there?

You may have a feel for the answer to the question, ‘Where are we?' You probably can sense that your financial condition is bad or headed south. However, you probably don't know just how bad it really is. By the time most systems decide they need a comprehensive rate analysis they need an average initial rate increase of 20 to 45 percent. They also need severe rate restructuring to make their rates fair. The comprehensive rate analysis will answer the ‘Where are we?' question in explicit financial detail.

You have already answered, at least generally, the ‘Where do we want to be?' question when you set goals. You did set goals, didn't you? The analysis will put some numbers to the choices you have already made. Those numbers might even convince you to decide differently and change your goals, funding plans, capital improvement plans or something else. Most systems find that, while their rates are too low right now, with reasonable adjustments they can actually afford to do much more than they thought they could.

Finally, your rate analysis will answer the ‘How do we get there?' question. It will show you exactly how to adjust your rates, fees, policies and ordinances. It will show you how to plan for future equipment replacements and capital improvements. And, your analyst will guide you in how to “sell” the proposed rates to your ratepayers.

Now that you have your goals solidified and the analysis to tell you how to reach your goals, it's time to do something about it.

Phase 3 – Adjust Rates

This is, of course, a political process and politics has a pretty bad reputation. However, you can gain ratepayer acceptance of your rate adjustment proposal by doing two things:

•  Get a Phase 2 comprehensive rate analysis, and make it clear to all that the analysis was sound and not influenced by politics.

•  Make it clear that the elected officials actually did or will use the results of the analysis to inform their rate adjustment decisions.

There are many issues to cover and excellent strategies you can use to keep the cool-heads with you and the CAVE people from opposing you in any organized fashion. Your rate setting specialist can give you guidance on these.

Going into a board or council meeting to consider rate adjustments is like going into battle. If you have not been getting or doing Phase 2 comprehensive rate analyses, then you have been going into battle without air support, artillery support, or even a walky-talky. You have been battered and bruised. You may have even assumed your current position because your predecessor didn't survive the previous unsupported battle or they went AWOL to escape it.

Because Phase 3 rate adjustments are supported by a Phase 2 comprehensive analysis, you will have cover for your rate setting decisions. Many times the enemy (not your cool-headed ratepayers because they will be with you, but the CAVE people) won't even contest this battle. So, take heart that this battle can be won, probably handily. That will set you up for lots of wins in the future. That is what Phase 4 is all about.

Phase 4 – Adjust Rates Again and Again, Incrementally

Incremental rate increases are those done during years in-between comprehensive rate analyses. These are small, simple inflationary increases made to allow revenues to keep track with costs as they rise with inflation. Like regular brushing and flossing, these increases are a do-it-yourself affair. They do not take rate structure fairness into account. However, since they are small increases done following soon after a rate restructuring, rates will remain fair enough for several years to come.

Phase 4 increases are pretty easy to sell because they are almost always small. This is how you do it.

Your board or council needs to revisit the rates once a year. To do that they need to look at what the previous Phase 2 comprehensive analysis predicted for this year and compare it to the system's current financial position and other indicators. Then, one of three things should happen:

If the predicted and current financial positions match closely, and if future needs are like those anticipated in the analysis, the board or council should increase rates by the factors recommended in the analysis. This is a slam-dunk easy adjustment.

If the two diverge modestly, the board or council should adopt rates that will get the system back on track. They can do that with some simple math. This is only slightly more complex than a slam-dunk.

If the predicted financial performance diverges wildly from the actual, a simple math calculation won't do. It's time for a new comprehensive analysis. The analysis is complex but the board or council's part is still easy to do.

Because these adjustments are small, few if any of your ratepayers will drag themselves away from everything else they have going on to concentrate on these adjustments. For such things they are willing to just let you take care of business.

In the author's experience, many systems can go about five years between comprehensive analyses by making incremental increases each year.

Conclusion

You want to take your system and your customers to a destination – great rates and great service. You decide that destination by setting goals in Phase 1. Then you need a map, a Phase 2 comprehensive analysis, if you hope to find your destination. You can't reach any destination without starting. Phase 3 rate setting gets you on your way. Once you have arrived at your destination you can't stay there without paying the costs you will incur in the future. Incremental rate increases, Phase 4, will keep you where you want to be.

Author Bio and Contact Information

Carl Brown is President of Carl Brown Consulting, LLC ; specializing in water and sewer system rate analysis and rate setting, asset management program development and training nationwide. Mr. Brown may be contacted at Carl Brown Consulting, LLC , 1014 Carousel Drive , Jefferson City , Missouri , 65101 , Phone (573) 619-3411, E-mail carlbrown@mchsi.com. Web site: www.carlbrownconsulting.com.

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Editor's Note: This article, republished here by permission, is extracted from chapter 15 of “How to get Great Rates,” a book written by Mr. Brown. To learn more about how you should set your system's rates, attend one of the rate setting workshops Mr. Brown will conduct for Association members in May.

Summary

Rate setting has a beginning, middle and end, and it has some basic steps one must complete to do it well. Those steps encompass determining the state of mind of all involved and carrying out the four phases of rate setting.

Introduction

Here we are, wrapping up your indoctrination in rate setting. You have learned much about the process. Soon you must transition from learning it to actually doing it. If you don't do that, we have failed.

You may be one of those readers who wanted a checklist or an easy to use template to make this rate setting task sure and easy. I told you early on in this guide that there is no cookbook for this kind of work. Now you're thinking, ‘He lied! He has a checklist.'

While there is no one size fits all cookbook for rate setting, there are some basic things you need to be aware of and do. These were discussed at some length earlier in this guide so they are summarized in bullet-point fashion here.

The Game Plan

Take stock of your frame of mind, and the frame of mind of your ratepayers

Determine your system's financial situation

If you got a comprehensive analysis by a specialist within the last three years, review that analysis. Is the system on track financially compared to the analysis predictions? If so, skip down to the section on Phase 4. Otherwise, read on.

Phase 1 – Set goals

Make a first cut decision about where you want your operating ratio, coverage ratio, affordability index, and other indicators and balances to be. The analysis will refine these so don't labor over this task.

  Decide if you want to use advanced asset management strategies, which ones, when and how. Again, don't labor over this.

Phase 2 – Do or get a comprehensive rate analysis

If you or someone else associated with your system has been trained in comprehensive rate analysis, you're good at it and you are inclined to do it, do your own rate analysis. Otherwise, seek outside help.

If an assistance provider like your rural water association or a state technical assistance agency has a rate analysis specialist who can do your analysis promptly and you are inclined to use them, do so if their service will yield the best return on investment.

If none of the above works for you, seek the services of a rate analyst using the strategies in this guide. Acquire their services smartly and promptly.

Work closely with your rate analyst to make sure they get good data to work with, that they clearly understand what you are trying to do, and to make sure that you clearly understand the actions that the analyst recommends you take.

As an example, part of a comprehensive rate analysis appears in Appendix VI. You can also view this analysis at http://carlbrownconsulting.com/Victoria.pdf .

Phase 3 – Do the initial rate adjustment

Inform your decision-making body, and then your ratepayers, what the analysis results indicate they should do with rates, fees, policies and other issues. In all likelihood, your analyst's service will include doing this for you.

Based upon feedback from your decision-makers, prepare proposed changes to the rate ordinance or draft a rate resolution, as appropriate, that will enact the new rates if passed.

Present the ordinance or resolution to the decision-making body for their consideration.

Pass an ordinance or resolution. Also make all recommended changes to policies and procedures. Start with the high-dollar and most critical items first. However, if an item or issue is particularly difficult or time consuming to solve, temporarily skip it, solve other issues quickly then return to the difficult issue. Don't let a small but difficult issue hold up progress on other fronts.

Make the needed changes to your rate chart, your billing software program, Web page and wherever else it is necessary to effectuate the new rates.

Continue or begin to set aside funds as recommended for equipment replacement, capital improvements and the like.

After the new rates go into effect, do checks to see that the system's finances begin to perform as modeled.

Phase 4 – Do follow up rate adjustments

Periodically, preferably annually at the beginning of each new fiscal year or near the anniversary of the initial rate adjustment, adjust rates incrementally. If the financial indicators from the analysis closely match the actual performance of the system, adjust rates by the percentages or amounts recommended in the comprehensive analysis for that year. If variances are larger, make larger adjustments on an equivalent percentage basis. When the analysis and actual performance cease to match well, it is time for a new comprehensive analysis – start at Phase 1 again.

Conclusion v

Like all other rate analysts, my livelihood depends on your using me. But you should strive to use me, or them, only once every three to five years or so. The first Phase 2 rate analysis recommendations will probably have you raise rates a lot and restructure rates severely because your rates are currently way out of whack. The second Phase 2 exercise, if you adjusted your rates properly the first time around and have since kept them current, should primarily be a rate restructuring. Hopefully it will be a light one at that. If you are preparing for an approaching capital improvement or some other large event and it was not modeled in the previous Phase 2 analysis, sure, rates will need to go up a lot, as well.

You will enjoy the greatest success if you can spend almost all of your time in Phase 4 and little time in the other phases. Frequent but small adjustments will be well received by your ratepayers. And, such adjustments will enable you to maintain a nice, even funding stream for your system with few problems.

Recall that early in this guide I made the point that people don't think of you at all unless there is a problem. Eliminate the problems, they won't think of you and, voila, you have success!

Your Charge

Having learned how to get great rates, you now have a decision to make. Are you going to actually do this stuff? Or, are you going to think, ‘Gee, that was kind of interesting. Maybe someday someone in the system should look into this rate adjustment thing further.'

I hope you will just do it, do it well and do it promptly. ‘Time is money,' ‘sooner is better than later,' ‘the only thing we have to fear…' and all those other great adages apply to rate setting, too.

Jump in. My experience tells me you will discover this. It looks overwhelming now. It will look easy when it is done.

Author Bio and Contact Information

Carl Brown is President of Carl Brown Consulting, LLC ; specializing in water and sewer system rate analysis and rate setting, asset management program development and training nationwide. Mr. Brown may be contacted at Carl Brown Consulting, LLC , 1014 Carousel Drive, Jefferson City, Missouri , 65101 , Phone (573) 619-3411 , E-mail carlbrown@mchsi.com. Web site: www.carlbrownconsulting.com.