What’s on the Horizon for Measuring Water Utility Financial Capability?
By Alanna Kinnebrew
The federal Clean Water Act (CWA) requires water, wastewater, and stormwater utilities to invest in upgrades and maintenance of critical water infrastructure to ensure the infrastructure stays within compliance. This includes replacing aging infrastructure as it approaches the end of its useful life, and meeting new requirements from the EPA. While water sector services are fundamental to ensuring the health, safety, and well-being of the consumer, these services can only be accessible if they are affordable for ratepayers. Water associations, have published documents, including “Developing a New Framework for Household Affordability and Financial Capability Assessment in the Water Sector” to aid the EPA in finding new ways to measure community affordability, especially when it comes to meeting new federal requirements. In September 2020, the EPA released a draft of an updated Financial Capability Assessment (FCA) Guidance, which is intended to help communities plan for these water infrastructure improvements. But, how much change will the new guidance potentially bring to local utilities?
Utilities work to find a balance between maintaining infrastructure and setting rates to what may be deemed affordable for their customer base. However, sometimes projects cannot immediately be paid for through a rate increase; therefore, a financial analysis is necessary to assess the community’s ability to pay for improvements. From the 1997 FCA, median household income (MHI) is the most widely used indicator of affordability, but it “has been especially criticized for masking the isolated pockets of poverty within a given area by assuming that the distribution of household incomes below the MHI is the same everywhere.” In another example, the United States Conference of Mayors (USCM), American Water Works Association (AWWA), and the Water Environment Federation (WEF) published a white paper in 2013 that stated that “there are several critical limitations to how EPA defines affordability . . . EPA’s reliance on metrics such as MHI is highly misleading as an indicator of a community’s ability to pay.”
Despite the critiques, the new FCA Guidance has not completely done away with using MHI in measuring affordability at the utility level but it has taken some suggestions from the New Framework document to more accurately demonstrate the financial burdens that these communities are facing. Below are the main takeaways from the proposed 2020 FCA Guidance:
1. Communities have options: The 2020 FCA will allow communities to submit information that may indicate the entire community’s capability to fund CWA control measures by giving 2 alternative approaches for assessing its financial capability.
Alternative 1 – This option can be completed by the community or by the EPA on behalf of the community and it is best suited for communities with lower cost control due to its simplicity. The foundation is still rooted in the 1997 FCA Guidance by retaining the first two metrics listed below, but it has expanded considerations of costs, poverty, and impacts on the population in the service area with incomes in the lowest quintile which is reflected in the last two metrics.
Alternative 1’s critical metrics:
Residential Indicator (RI) – cost per household as a percentage of MHI (the highly criticized metric)
Financial Capability Indicator (FCI) – six socioeconomic, debt, and financial indicators used to benchmark a community’s financial strength
Lowest Quintile Residential Indicator (LQRI) – cost per low-income household as a percentage of LQI
Poverty Indicator (PI) – five poverty indicators used to benchmark the prevalence of poverty within the service area
Some communities have a range of incomes but also have contiguous areas of population that have difficulty paying for their water services. As such, EPA has incorporated LQI into the LQRI, a critical metric for calculating the impact of costs on a community’s households. With the incorporation of LQRI and PI in the assessment, the intent is to provide a more common basis for discussions of financial burden among communities, tribes, and the EPA.
Alternative 2 – This option analyzes financial and rate models by looking at the impacts of rate increases over time on utility customers, including those with incomes in the lowest quintile. Those communities with more expensive CWA obligations can choose to employ this alternative due to its more detailed evaluation of financial capability over time. However, unlike alternative 1, the community must conduct this analysis itself.
Alternative 2’s critical metrics:
Financial and Rate Models
Poverty Indicator
2. Template, templates, and more templates: The proposed guidance has provided an ample number of worksheets and templates that appear relatively easy to follow and allow for the community/utility to fill in and complete the calculations based on data that can be pulled using the U.S. Census Bureau website. Throughout the appendices, instructions are provided that map out how to complete the necessary calculations along with “practice tips” that leave the user solely left with the task of gathering the necessary data needed to look at total CWA costs per household as a percent of MHI. This is especially important because it shows EPA’s intent of not only considering MHI when calculating the impact of costs on households but also the impacts to lowest quintile households.
With these enhancements, the 2020 FCA will hopefully serve as a way to more accurately demonstrate the financial burdens that communities face as well as increase the transparency of the EPA’s considerations as it endeavors to consistently apply these methodologies across the board. These new metrics are intended to more accurately reflect how much low-income communities can afford to pay for service, thus impacting the affordability of capital expenditures and operation and maintenance costs needed to ensure utility compliance with the CWA.
Where it stands:
As previously stated, this is the proposed FCA, but with the recent change in administration, a pre-publication has been made available until the official version is announced in the Federal Register. Currently, the 2020 FCA for CWA Obligation is undergoing review in accordance with the Regulatory Freeze Pending Review Memorandum that White House Chief of Staff Ronald Klain issued on January 20, 2021. This means that all newly released rules and regulations are on hold for review and approval by the newly appointed department or agency head for a minimum 60-day-period. Once the official version is announced in the Federal Register, the 2020 FCA will replace the 1997 Guidance for Financial Capability Assessment and Schedule Development.
This is part of a blog post series funded by the Georgia Environmental Finance Authority (GEFA).
Disclaimer: The opinions of the writers should not be considered legal advice or endorsement by GEFA.
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