Effective rate structures for water and sewer services help ensure sufficient revenue to cover utilities’ costs, allow for fair distribution of these expenses, and ensure straightforward accounting and administration processes. They are also easily understood by customers and staff alike, fostering transparency and trust.

Rate structures vary—including the rates themselves—depending on the specifics of each utility system and the community it serves. For example:

  • Flat rate systems offer the simplicity of the same charge for all users but lack the capability to discourage waste or consider the smaller users’ potential disadvantage.
  • Uniform metered rates keep a consistent price per unit of usage, making administration simple but failing to acknowledge economies of scale and extra costs for treating high-strength waste.
  • Increasing block rates can incentivize conservation and tie usage to the ability to pay but might be less beneficial for larger industrial and commercial users.
  • Decreasing block rates recognize economies of scale but offer a moderate disincentive for conservation.
  • Minimum bills cover the fixed costs of providing utility service, like salaries, wages, and debt. However, larger minimum bills impact small-volume users the most.

In addition to regular rates, there are several types of fees that can be utilized to manage a utility’s finances. These include tap fees, which serve as an access charge for initial setup costs, and reconnection fees to discourage frequent switching on and off the utility service. However, it’s important to avoid relying too heavily on these one-time fees, as they can be unpredictable and difficult to manage.

In some locales, there’s also the potential for property tax levies to be part of the rate program. Property tax levies might seem like an equitable solution—but they can lead to inequitable situations. For example, consider a storage unit owner, who doesn’t use much water/sewer but pays higher property taxes. That storage unit owner effectively subsidizes a car wash owner who uses high volumes of water/sewer but pays lower property taxes.

What is a rate study?

A rate study is a financial analysis conducted by a utility to review its historical revenues and expenses and to project its future performance. It is typically performed in conjunction with large capital projects, but regular, routine reviews can also provide significant benefits.

Regular rate studies offer a strategic tool for fine-tuning rate structures. They make it possible to implement small, incremental changes over time, rather than large, unexpected increases that can shock customers and disrupt budgets. Regular studies also allow for the proactive anticipation of inflation and other economic changes, reducing the need for debt and enabling more sustainable financial management.

Benefits of a utility rate study

A utility rate study offers several advantages. For starters, it pinpoints the total revenue requirements and expenditure realities, ensuring revenue predictability and stability in both short and long-term periods.

Moreover, it contributes to a fair distribution of total service costs by considering different classes and usage patterns of ratepayers. This assessment plays a significant role in directing the design, or redesign if necessary, of utility rates.

Through a utility rate study, unexpectedly large, one-time increases to user rates can be avoided. Instead, it facilitates a smoother ratepayer experience by setting realistic expectations for future rate increases.

Beyond this, when rate increases are required to maintain or improve the quality of product and service, a utility rate study can encourage buy-in from both staff and customers. Ultimately, the process of conducting a utility rate study culminates in the creation of a valuable tool to assist with ongoing financial management and informed decision-making.

Two approaches to rate studies

There are two main approaches to conducting rate studies. The first is a formal, published study, designed for public consumption. The second is an informal assumption study or model, which is primarily intended for the benefit of staff and elected officials. Both approaches have their unique benefits and can be used in conjunction to provide a comprehensive view of a utility’s rate structure.

Either way, the rate study process involves careful evaluation and analysis. It starts with understanding the need for a rate study, then proceeds to include a financial analysis, a review of historic revenues and expenses, and projections of future performance. Usually, the process should focus on a three-to-five-year period—and potentially even 10 years. Looking beyond 10 years tends to introduce hard-to-model business-cycle variables.

The process also includes considerations around debt, depreciation, and other financial indicators.

Implementing a change

Once a rate increase has been determined as necessary, the question then becomes how to implement and communicate this change effectively. This could involve adjusting the base rate, usage rate, a capital project surcharge to pay for specific projects, or even property tax levies. The key is to communicate these changes clearly and transparently, taking into consideration potential impacts on different customer groups.

Striking a balance

A well-designed rate structure ensures sufficient revenue, fair distribution of costs, and a straightforward administrative process. Regular rate studies facilitate the fine-tuning of this structure, allowing for adaptation in line with inflation and other economic changes. Ultimately, with clear communication and strategic implementation, it is possible to strike a balance between the financial wellbeing of the utility and the affordability of its services for its users.

Learn more about how UMB Bank, n.a. Public Finance can support your organization’s financing and capital needs, or contact us to be connected with a public finance specialist.


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