1. 1 Washington Municipal Treasurers Association (WMTA) Conference Utility Rate Studies Presentation by: Angie Sanchez Virnoche Senior Project Manager – FCS GROUP April 2008 Redmond Town Center, 7525 166 th Avenue NE, Suite D-215, Redmond, WA 98052; T: (425) 867-1802 F: (425) 867-1937 www.fcsgroup.com

2. 2 Presentation Outline Overview Revenue Requirement Operation Costs Capital Costs Cost of Service Rate Design Presentation of Results

3. 3 What is the Purpose of a Rate Study? To meet the minimum financial requirements and commitments of the utility To ensure that formal and informal financial policies can be met, such as meeting minimum operating and emergency reserves To provide long-term stability To provide a secure funding program for planned capital improvements, upgrades, betterments, and system replacements To maintain the long-term health and integrity of the utility system

4. 4 What Are You Trying to Accomplish? Revenue Requirements Connection Charges Cost of Service Rate Design Public Process 1. Revenue Sufficiency 2. Capital Funding Strategy 3. Fairness/Equity 4. Growth Pays for Growth 5. Policy Guidelines 6. Economic Development Incentives 7. Respond to Changing Customer Base 8. Satisfy Debt Requirements

5. 5 Rate Study Source Documents Revenue Requirements Connection Charges Cost of Service Rate Design Public Process Capital Improvement Program (6-10 years) System Planning Documents Customer Base Growth Forecast Historical Financial Records (1-3 years) Current Year Beginning Fund Balances Current Year Operating Budget Debt Service Schedules Bond/Loan Covenants Fixed Asset Listing Rate and Fee Schedules Detailed Customer Billing Records Water Production/Sewer Treatment Plant Records Special Service Agreements

6. 6 CAPITAL FUNDING PLAN ALLOCATE COSTS TO CUSTOMER CLASSES RATE DESIGN FUNCTIONAL COST ALLOCATION REVENUE REQUIREMENT CUSTOME R PEAK FIRE BASE CUSTOME R STRENGTHFLOW OPERATING BUDGETS ECONOMIC ASSUMPTIONS CUSTOMER STATISTICS FISCAL POLICIES DEFINE CUSTOMER CLASSES VARIABLE CHARGESFIXED CHARGES CUSTOME R QUALITYQUANTITY RECYCLING COLLECTION CUSTOME R YARD WASTE WaterWastewaterStorm Solid Waste Overview of Rate Study Process DISPOSAL

7. Revenue Requirement “Defining Overall Needs”

8. 8 A Successful Rate Study is… A blend of data from ALL departments: finance, engineering, customer service, administration Not simply just a financial exercise!

9. 9 Revenue Requirement Elements Fiscal Policies Target reserve levels; debt service coverage, system reinvestment funding Forecast of Revenue (rate revenue + miscellaneous) Be careful not to start with beginning balance one time revenue that can mask rate evaluation Ongoing revenue should support annual needs Operating & Maintenance Expense Capital Program & Impacts of Capital Financing Plan Identify capital needs Develop funding plan (rates/debt financing/connection charges/reserves) Revenue Requirement = Fiscal Policies + O&M + Debt Service + Rate Funded System Reinvestment (capital) Purpose: To determine the amount of annual rate revenue necessary to fund all utility financial obligations.

10. 10 Operating and Capital Costs Operating Costs Use historical/budget expenditures Include known operational changes (staffing, regulatory programs, etc.) Forecast future costs Capital Costs Define capital needs Identify available resources (grants, developer donations, connection charges, rate funding, reserves, bonds/loans) Develop funding strategy Identify annual financial impacts (sensitivity analyses)

11. 11 System Reinvestment Funding To ensure ongoing system integrity through reinvestment in the system To charge customers commensurate with the consumption of facility useful lives (rate equity) To maintain rate stability System replacement funding benchmarks Depreciation expense Depreciation expense net of debt principal Replacement depreciation Sinking fund

12. 12 Example Capital Fund Transfer from Rate Revenue

13. 13 Total Rate Revenue Impacts 0.0% 2.0% 4.0% 6.0% 8.0% 2007201420212028203520422050 Rate Increase w/ Annual Rate Funded Contribution Rate Increases w/ Debt Rate Increases with cash (pay as you go) funding only Impact of Alternative Capital Funding Sources

14. 14 Debt Service Coverage Example

15. 15 Putting It All Together Revenue Requirement Forecast

16. 16 Rate Transition Planning

17. 17 A lot of utilities look at the budget year and stop Too short a time frame, always playing catch up Ability to look ahead 3, 5, 10 years allows more thoughtful planning and fewer surprises Capital funding should be viewed independent from operating activities Always looking forward, each adjustment makes the projection more certain When possible, develop a rate transition plan that smoothes rates over the time period being reviewed Summary of Revenue Requirement

18. 18 Common Reserves Purpose Industry Standard Operating To provide a liquidity cushion to accommodate normal cyclical fluctuations in addition to protect against adverse financial performance. 45-90 Days Operating Expenses or % of operating expenses Contingency To meet unexpected emergency outlays. Not intended to cover catastrophic loss. Cost of major repair/replacement (main break, pump station). 1% – 2 % of total Utility Asset Value Capital To provide a source of funding for unexpected cost increases in the capital program and project cost overruns. Average Annual Capital Costs or Multi-year rolling average Rate Stabilization To off-set unplanned revenue shortfall or unexpected increases or non-recurring expenditures by allowing gradual increases over a period of time. Expressed as a percent of revenue (10-25%) Debt To meet requirements stated in debt issuance covenants or documents. Typically =one annual debt service payment maintained for entire term

19. Cost of Service “Equity Evaluation”

20. 20 Cost of Service Elements Group customers into classes (single family, multi family, commercial, irrigation, etc.) Different customer classes place different demands on the system An equitable distribution of cost shares that considers District specific data: Measures of usage and demand (level and pattern) Planning, engineering and design criteria Facility requirements (fire protection/peaking) Cost of service analysis determines total cost by class unit costs ($/customer, $/usage) The fundamental question: Do cost differences exist to serve the various customer classes of service?

21. 21 Role of Cost of Service Provides a rational basis for distributing the full costs of utility service to each class of customer Distributes utility costs amongst customer classes according to the unique demand each class places on the system An equitable distribution of cost shares that considers utility-specific data Measures of usage and demand (levels and patterns) Planning, engineering, and design criteria Facility requirements (fire protection, peaking, etc.) End result Total cost by class Unit costs ($/customer, $/usage)

22. 22 Analytical Steps of a COSA Step 1: Functionalize The preliminary arrangement of costs according to functions performed by the utility. Major functions are defined by system of accounts (e.g. treatment, transmission, distribution, collection, disposal, customer service, administration, etc.). Step 2: Classify The process of classifying functionalized costs to cost components (e.g. base use, peak use, flow, customer). Use of “generally accepted” methodologies Discussion with staff Management objectives Step 3: Allocate The assignment of classified cost to customer classes of service.

23. 23 Cost Allocation Customer $ 92,403 Fire Protection 51,071 Base Costs 988,325 Extra Capacity 855,989 By Function TOTAL $ 1,987,788 By Customer Class SF Residential $ 906,211 Low Income 9,067 Commercial 497,000 Multi-Family 532,045 Irrigation 43,465 TOTAL $ 1,987,788

24. 24 Cost of Service Summary Equity Evaluation by Class Existing Rates Cost of Service $ Change% Change SF Residential $912,527$915,341$2,8140.31% Commercial499,750497,924($1,826)-0.37% Multi-Family523,389533,097$9,7081.85% Irrigation23,34641,426$18,08077.44% Total$1,959,012$1,987,788$28,7761.47%

25. Rate Design “Collecting the Target Revenue”

26. 26 Goals of Rate Design Collect the target level of revenue Cost-based ( reflect the way cost incurred ) Ability to implement, administer, understand Policy objectives Conservation Risks (revenue stability) Customer impacts Social objectives Affordability Lifeline rates

27. 27 Flat Rates When Used: No Water Usage Data Consistent Usage, Demand Patterns How Applied: Flat Monthly Charge per Customer or Equivalent Customer Advantages: Low Administrative Cost Stable Revenues Disadvantages: Not Proportionate to Demand No Incentive to Conserve Water Single Family$20 /mo. Multi-Family$15 /mo. Commercial$75 /mo. Example $ Sewer Single Family$40 /mo. Multi-Family$30 /unit Commercial$40 /mo./ERU

28. 28 Fixed Charge Plus Volume Rates When Used: Water Usage (or Sewer Volume) Data Available Consistent Usage, Demand Patterns Simplicity/Understandability are Highly Valued How Applied: Fixed Charge per Customer or per Equivalent Customer (e.g. Meter Size) Volume Charge per Unit of Water Consumption [ccf = 100 cubic feet = 748 gallons or 1000 gallons] Advantages: Reflects Costs Proportionate to Use May Adequately Address Efficiency/Conservation Concerns Disadvantages: Less Stable Revenues compared to flat rates Doesn ’ t Reflect all Cost Distinctions Water Fixed Charges$10/mo. Volume Charge$1.00/ccf Example $ Sewer Fixed Charges$5/mo. Volume Charge$3.00/ccf

29. 29 Fixed Charge with Allowance Plus Volume Charge When Used: Water Usage Data Available Consistent Usage, Demand Patterns How Applied: Fixed Charge Includes Volume Allowance Volume Charge For Usage Over Allowance Advantages: Charge Increases for High Usage Base from Fixed Charge Disadvantages: Higher Charges for Low Volume Customers Reduced Incentive to Conserve Water Fixed Charges$15/mo. (includes 5 ccf) Volume Charge$1.00/ccf (for usage over 5 ccf) Example $ Sewer Fixed Charges$30/mo. (includes 7 ccf) Volume Charge$5.00/mo. (for usage over 7 ccf)

30. 30 Increasing Block (Tiered) Rates When Used: Water Usage Data Available To Reflect Peak Capacity Costs As Conservation Incentive How Applied: Volume Charge Increases as Thresholds are Crossed Advantages: Encourages Conservation Better Relationship to Costs Disadvantages: Can be Unfair to Large, Stable Users Highly Unstable Revenues Water Volume Charge 0-10 ccf $1.00 / ccf 11-20 ccf $2.00 / ccf Over 20 ccf $3.00 /ccf Example $ Sewer (rarely used) 0-10 ccf$3.00 / ccf 11-20 ccf$6.00 / ccf Over 20 ccf N/A

31. 31 Seasonal Rates When Used: Water Usage Data Available To Reflect Peak Capacity Costs As Conservation Incentive How Applied: Volume Charge Varies by Season May Combine Other Rate Forms Advantages: Encourages Conservation Better Relationship to Costs Disadvantages: Can be Unfair to Large, Stable Users Highly Unstable Revenues Water Volume Charge Winter $1.00 / ccf Summer $2.00 / ccf Example $

32. 32 Other Rates Volume Based Sewer Rates Rate based on estimated sewage volume Winter water use used as volume basis Supports water conservation goals Outside City Rates - Commonly a rate multiplier ( 1.10 - 1.50) Premised on “Renter” rather than “Owner” Higher costs due to location Benefits of utility government w/o costs Wholesale Rates Reflect limited service commitment Includes a return on utility investment May include charges for unique services, facilities Usually lower rates than retail rates Industrial Rates Large Customer w/ unique characteristics Often “ tailored ” to directly reflect service costs

33. Presentation of Findings

34. 34 Presentation of Findings Workshop vs. Regular Council Meeting More interactive/casual Allows for more detail Best if first rate study process Tell the Story - Step by Step Keep it at a higher level Avoid too many details Highlight key areas – cause of increase Summarize results early on in the presentation Use Sample Bill Comparisons Different customer classes at varying usage levels Identify Policy Decisions Required

35. 35 Public Communications Tie to Important Public Policy Issues Environment & Habitat Preservation Resource Conservation Responsible Management Equitable Treatment of Citizens Safe and Reliable Water Economic Development Opportunities Stewardship and Legacy Link Rates to Key Outcomes Improved Service Reliable, Secure Systems More Stable Rates Responsible Stewardship Foster Growth; or Growth pays for Growth

36. 36 What’s Right for You? What do you wish to accomplish? What information can you use? What structures can your system handle? Will the message be received? Is it worth it?

37. 37 About the Speaker ANGIE SANCHEZ - SENIOR PROJECT MANAGER B.S., Business Administration, Oregon State University Angie Sanchez is a senior project manager and shareholder for FCS GROUP with over 14 years of experience. Angie has provided financial services for water, sewer, stormwater, solid waste and electric utilities. Her project work includes multi-year financial planning, cost of service studies, rate design restructuring, capital/infrastructure planning, funding alternatives, cost benefit analyses, reserve analysis, and community education and involvement. Angie is often asked to speak at state and national professional conferences and has recently given presentations on topics such as Rates for Small Systems, Utility Rate Strategies and Techniques, Indirect Cost Allocation, and Asset Management Systems. She is a member of the American Water Works Association (Rates and Charges Subcommittee and the Standards Committee); the Washington Finance Officers Association, and the Oregon Municipal Finance Officers Association. Angie can be reached at 425-867-1802 x230 or angies@fcsgroup.com.