Pain, With Gain: Independent Reviews to Challenge and Improve Utility Financial Outcomes

Summary Today's water industry provides clean drinking water, sanitary sewer, and stormwater management services, as it always has, but the management and public policy aspects of water utility management bear little resemblance to the structures and processes of the past. As much as technologies and regulatory limits have changed, changes in the institutional framework and in customer and stakeholder expectations have more profound on the daily obligations of senior management. This presentation offers insight into the benefits of a truly independent review process regarding rates, rate setting, and cost of service analyses. Bringing in industry professionals with no prior involvement in as part of a review process is necessarily complicating and somewhat disruptive. But the benefits of an unhindered review can be profound and lead to increased support for rates and necessary rate management practices in a community. Abstract Well-run utilities invest time and resources to create the strong financial plans necessary for a sustainable future. Comprehensive rate studies are part of that process, following industry best practices and tried and true methods to craft rates to meet the agency's objectives and recognize institutional and legal constraints. All rate studies rest on fundamental assumptions, the quality of available data, policy direction and shared understanding, and reliance (generally entirely appropriate) on assumptions and judgements from the past. To master the multitude of details necessarily involved in rate studies, utility staff and consultants must dive deeply into the particulars, unavoidably losing a degree of independence in the process. For this reason, a fresh perspective to conduct thoughtful and diligent top-to-bottom review of the process and work products can provide serious value in the form of improved outcomes, transparency, and buy-in from everyone involved. This presentation will summarize the following unique benefits of this form of independent review using recent work with the City of San Diego Independent Budget Analyst (IBA) and Public Utilities Department (PUD), and the City of Sacramento City Auditor's Office and Department of Utilities (DOU) conducting different but similar independent reviews of utility plans and studies. Three key ideas are emphasized: - Question everything — Independent reviewers should not be involved in the project at any point prior to reviewing a complete and final work product, including sources of data, data availability, current assumptions, historical assumptions rolled forward from previous studies, and various other undocumented input parameters. As a result, the reviewer has very little room to offer the benefit of the doubt, requiring inquiry into anything and everything that was not immediately apparent. One example, was the review of combined sewer system (CSS) cost allocation factors for cost-sharing between Sacramento DOU's Storm Drainage and Wastewater funds. With little to no explanation in the report, a historical split of 75%/25% was used to allocate CSS costs between the Storm Drainage and Wastewater funds, respectively. Inquiry and investigation into this topic led to development of alternative allocation schemes based on flow, capacity, and water quality parameters, and after consideration a combination of flow and capacity were used to present alternative financial planning results based on a modified approach. The change provided a stronger cost basis for both storm drainage fees and wastewater rates, improved the quality of the allocation basis for this item to be more in line with other cost allocation assumptions. - Healthy skepticism — As rate consultants we are a group of primarily accounting, finance, and economics backgrounds. As a result, it occasionally easy to focus our advice and our professional judgement in those areas, but when somebody from engineering says 'the value should be X' we accept the input without significant questioning. In our role as reviewer we balanced the need to be diligent, thorough and independent with the fact that we are not here to be an obstacle to ensure we provide the greatest value to the City. To this end, we were occasionally compelled to push back on some of the more technical points. When summary statistics suggested an out-of-balance wastewater mass balance equation, we drilled into all inputs and assumptions, ultimately landing on unusually high loading factors attributed to the residential customer class as an anomaly. Though the general approach was not unusual or even necessarily significantly lacking, when considering the cost allocation results, the assumptions appeared to be unsupported in this specific circumstance. Lacking more complete or up to date information at this time, PUD agreed that a more comprehensive sampling and loading analysis of both residential and commercial customer classes would be completed before the next cost of service study. - Propose independent alternatives — As the consultant we evaluate numerous alternatives in multiple facets of nearly every study; however, these are typically driven by the client based on conversations focused on organizational objectives. By contrast, independent reviewers follow the path of the study as documented in a report and with that fresh perspective, come up with questions and suggest alternative outcomes for consideration. Recognizing the models used to develop the original plans were not our own, and we were not tasked with developing new rates or plans for adoption, we stopped short of developing recommended rate changes. In recent projects we limited our analysis to high-level impacts in terms of required cumulative rate increases, or to analysis of the customer class level breakdown of potential revenue generation. For PUD's wastewater COS, we presented this information for each individual recommendation, and for the combined effect of all recommendations to clearly illustrate the relative magnitude of every change. This process also helped illustrate the connectivity between financial planning decisions and customer class impacts as changes to use of fund balance impacted the percentage distributions out of the COS/rate model. Also, because we were not necessarily following the guidance of PUD in determining what alternatives to present, we simply followed the data and our own professional judgement (incorporating that point of healthy skepticism) to consider alternatives that may be initially viewed as unpopular. For example, one recommendation included greater use of fund balances to reduce the first year's rate increase. While we recognized and appreciated the rationale for the first year's increase to be higher, and the desire for larger fund balances to maintain a healthy amount of conservatism in the forecast, we offered the perspective that sufficient levels of conservative estimates might already have been layered into the analysis. The fresh perspective revealed the layering of conservatism, which was entirely understandable as a part of the initial rate process, during which it would have appeared reasonable to choose the conservative option every time. Some of the recommendations from these projects were implemented, some were not. This is not unexpected or troubling. The success of the independent review process is not contingent upon full, or even partial implementation of any resulting recommendations. Embracing a serious independent review process assures stakeholders that the analysis was thoroughly vetted; that independent recommendations were received, documented, and a response provided; and that transparency with decision makers and the public was truly maximized. The independent rate review process is not a substitute for sound financial planning and analysis, it serves to demonstrate the quality of the process and to build support by contributing light, openness, and accountability.