2016 WCGFOA Conference

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1 2016 WCGFOA Conference Considerations in Setting User Rates September 22, 2016 Andrew Grunda Watson & Associates Economists Ltd.

2 Introduction Having established municipal finance policy objectives regarding fiscal management, and considerations for optimizing user fee revenue sources from benefiting parties, the focus of this presentation is to review different user fee methodologies related to service delivery/costs and fee structures alternatives to achieve these objectives 1

3 User Fee Methodologies Types of user fee methodologies: Service Channel Operational Fees Hybrid Recreation Fees Capital Asset Lifecycle Fees Capital Development Cost Fees Spectrum of User Fees Service Channel Hybrid Capital Asset Lifecycle Capital Costs/ Development Operating Costs Capital Costs 2

4 Service Channel Processing Fees Service costs for recovery are largely operating Recover direct and indirect operating costs of a municipal service delivery channel User fee examples: planning applications, building permits, engineering inspections, licensing Not driven by vertical department structures, but by horizontal service delivery process Recovers costs based on level of effort contributed by all municipal staff involved in 3 service channel

5 Service Channel Processing Fees Activity-based fee modeling used to measure processing efforts (capacity assessment/ benchmarking) and quantify direct and indirect cost consumption Reserve funds established, where statutory permissible, to provide service continuity and sustainability Fee structures developed using flat rates (base charges and surcharges) and constant/declining block rates (variable costs), providing consideration for service demand characteristics 4 (e.g. economies of scale) and economic factors

6 Service Channel Processing Fees 5

7 Service Channel Processing Fees Processing Capacity Assessment Total application/permit processing time per position for each costing category X Historic average annual application/permit volumes for each costing category = Annual processing time for each application/permit costing category by direct staff position Calculated as a percentage of total available processing time per direct participating staff member 6

8 Service Channel Processing Fees Service Sustainability Reserve Fund Reserve Accumulation To Target Reserve Withdrawals Actual Permit Volumes Mean Application Volumes Across Modeling Time Period Reserve Fund Balance Target Expressed as # of Mean Application Years Lost During Downturn 7

9 Service Channel Processing Fees 8

10 Hybrid Service Programming Fees Characteristics of both Asset Lifecycle & Service Channel fee types Facility/asset rehabilitation/replacement component Program service channel component User fee examples: parks, recreation, library and cultural user fees Fees cover both facility rental (e.g. ice pad hours) and program costs (e.g. learn to skate) 9

11 Hybrid Service Programming Fees Activity-based costing methodology used to quantify programing cost component, with facility rental capacity used to address annual OM and capital replacement Fee design must recognize price elasticity challenge of users and program policy initiatives Membership/registration fees (flat rate) and hourly/class fees (constant rate) fee structures generally provided 10

12 Hybrid Example Recreation Fees Tax based support approaches 11 Approach Advantages Description Disadvantages Fixed Rate Option Council adopts a policy of a uniform cost percentage for tax based support to recognize the broader community benefits associated with Community Services (e.g. 25% of costs) Affiliated program discounts are financed within user fee cost allocation (e.g. 75% of costs) Tax based support consistency User fee reflective of cost of service Stimulated efficiency in service delivery Level of tax support may price services above/below competitors Leakage of users to surrounding communities resulting in declining volumes, lower revenue (downward spiral) Widening gap between prime time vs. affiliated discounts or alternatively minimal discount levels Variable Rate Option Affiliated program policy dictate the amount of discounts Market competitiveness dictate the prime time pricing policies Residual cost shortfall financed through tax based support Ensures user fees are competitively priced, thus reducing user leakage Limited financial risk for user groups Addresses affordability issues User fees are not reflective of costs, which does not promote efficiency Additional financial risk absorbed by tax base

13 Hybrid Example Recreation Fees Suggested approach to fee determination Steps Description Market Comparison Step 1 100% Cost Level Allocate costs to functional level (i.e. ice pads, pools, rooms, gyms and parks) Undertake market comparison with surrounding area rates to determine necessary tax Step 2 Tax Support Level Step 3 Inter-rate Funded Affiliated Program Discounts Step 4 Additional Tax Support Rerun functional level cost allocation with assumed tax support (i.e.75% fee based vs. 25% tax based) Determine amount of affiliated program discounts and rate impacts assuming inter-rate funding Determine if additional tax based support is required / available to fund affiliated program discounts given market position support Undertake market comparison with surrounding area rates to determine affiliated discount funding Market ability of rates including affiliated program discount funding 12

14 Capital Asset Lifecycle Fees Majority of service costs are capital asset intensive Full cost rates recovering operating costs and asset lifecycle capital costs Costing incorporates long-term asset management plan to address infrastructure deficit Depending on lifecycle timing, capital costs could be direct capital expenditures, reserve/reserve fund transfers, debt repayment User fee examples: water, wastewater and storm rates, waste management tipping fees 13

15 Capital Asset Lifecycle Fees Traditional budget structures more commonly used to assess operating costs, compared with activity-based approach, however indirect cost attributions should be incorporated Long-term capital needs and funding assessment is fundamental to sustainable funding model and fee structure: 14 Asset management plans, in the context of lifecycle capital needs (sinking fund analysis) Growth-related capital needs and service extensions to private serviced areas, including rate-based requirements Reserve/reserve fund continuity forecasts

16 Capital Asset Lifecycle Fees Rate structures include a variety of options addressed later in this presentation: Flat Rates Constant Rates Declining Block Rates Increasing or Inverted Block Rates Humpback Rates 15

17 Capital Asset Lifecycle Fees Drivers: Legislation Local Issues Health & Safety Issues Technical Innovations Financing Options: Reserves/Reserve Funds Development Charges Municipal Act XII Debt Limit Grants Growth Forecast Capital Works Requirements Capital Budget Forecast Draws from Reserves/ Reserve Funds Operating Contribution to Capital Capital-Related Expenditures Reserves/ Reserve Funds Operating Budget Forecast Contributions to Reserves/ Reserve Funds User Count and Profile Consumption Forecast Rates Forecast 16

18 Capital Development Cost Fees Service costs exclusively capital and associated project costs Funds growth-related capital needs in permitted asset classes (i.e. development and new service connections) User fee examples: development charges, development cost charges, servicing fees, capital charges, connection charges Recovers costs associated principally with initial asset construction, limited rehabilitation or replacement 17

19 Capital Development Cost Fees Growth pays for growth philosophy shelters existing development from the capital costs of serving new development/customers Project specific cost allocations based on service level assessments/benchmarks and engineering specifications Fee structures generally follow a constant rate structure (i.e. fee per dwelling unit, measure of land area or gross floor area) 18

20 Capital Development Cost Fees 19

21 Rate Structure Alternatives Typical rates structure alternatives: Flat Rates Constant Rates Declining Block Rates Increasing or Inverted Block Rates Humpback Rates 20

22 Flat Rates Consistent rate applicable to all users, calculated by dividing the total number of users into the costs to be recovered Does not recognize differences in consumption but provides uniform spreading of costs across all users Some municipalities define users into user classes of similar consumption patterns, i.e. commercial, residential or industrial user, and charge a flat rate by user class 21

23 Flat Rates No meters are required to facilitate this method, but an accurate estimate of the number of users is required This method ensures a set revenue for the collection period but is not sensitive to consumption, hence may cause a shortfall or surplus of revenue collected 22

24 Flat Rates "Rate Structure" "Impact on Individual Customer" Cost Per Unit Total Bill Charged Volume Volume 23

25 Constant Rates Volume-based rate where the consumer pays the same price per unit consumed, regardless of the volume The price per unit is calculated by dividing the total (net) cost of the service by the total volume used by total consumers The bill to the consumer climbs uniformly as the consumption increases. This method closely aligns the revenue recovery with consumption Revenue collected varies directly with the consumption volume 24

26 Constant Rates Cost Per Unit Total Bill Charged Volume Volume 25

27 Declining Block Rates This rate structure charges a successively lower price for set volumes, as consumption increases through a series of "blocks". Typically, the first, or first and second blocks cover residential and light commercial uses. Subsequent blocks normally are used for heavier commercial and industrial uses. This method requires the collection and analysis of consumption patterns by user classification to establish rates Requires weighting of block volumes 26

28 Declining Block Rates Cost Per Unit Total Bill Charged Volume Volume 27

29 Increasing or Inverted Block Rates Works essentially the same way as the declining block rate, except that the price of water in successive blocks increases rather than declines The consumer's bill rises faster with higher volumes used This method requires, as with the declining block structure, the collection and analysis of consumption patterns by user classification to establish rates at a level which does not over or under collect from rate payers Requires weighting of block volumes 28

30 Increasing or Inverted Block Rates Cost Per Unit Total Bill Charged Volume Volume 29

31 Humpback Rates Combines the Inclining Block rate at lower volume usage and a Declining Block rate for high volume users Meant to blend the conservation elements of the Inclining Block rate with the economic development benefits of the Declining Block rate As with the other block structures, the collection and analysis of consumption patterns by users. Requires weighting of block volumes in the calculations 30

32 Humpback Rates 31

33 Base Monthly Charges A base charge is a fixed sum which is imposed per bill whether any billable volume is read in the meter use ensures that contributions are being made towards the service even if no use of the system is being made by the customer (i.e. on vacation) Historically, a base charge often reflected recovery of meter reading/billing/collection costs, plus administration 32

34 Base Monthly Charges More recently, many municipalities have started to establish base charges based on ensuring a secure portion of the revenue stream which does not vary with volume consumption Generally, municipalities with customers with small sized meters have one monthly rate for all meter sizes For municipalities with larger users, will vary the monthly charge based on meter size (i.e. the larger the meter, the higher the charge) 33

35 Rate Structures Examples Municipality ABC Existing Water Billing Rates Municipality ABC Existing Wastewater Billing Rates ¾" $15.69 ¾" $ " $ " $ ½" $ ½" $ " $ " $ " $ " $ " $ " $ " $ " $ " $ " $ " $ " $ Non-Metered Customers Monthly Flat Rate Base Charge Constant Volume Charge $0.523 per m 3 $0.721 per m 3 Increasing Volume Charges $26.67 Non-Metered Customers Monthly Flat Rate Base Charge Constant Volume Charge Increasing Volume Charges $0.481 Block 1 per m 3 $0.663 Block 1 per m 3 $0.649 Block 2 per m 3 $0.895 Block 2 per m 3 Note: Assumes 75% of Volume is in Block 1 & 25% in Block 2 $40.01 Decreasing Volume Charges Decreasing Volume Charges $0.573 Block 1 per m 3 $0.790 Block 1 per m 3 $0.373 Block 2 per m 3 $0.514 Block 2 per m 3 Note: Assumes 75% of Volume is in Block 1 & 25% in Block 2 34

36 Assessment of Alternative Pricing Structures Adoption of one particular pricing structure is normally a function of a variety of factors: Administrative Simplicity ability for the public to understand the basis for the charge calculation of the bill is easily understood by the ratepayer Equity definition can vary depending on circumstances should be viewed broadly as part of achieving what is best for the municipality as a whole Conservation Importance of promoting conservation due to scarcity, environmental stewardship or financial restrictions for expansion increasing block rate structure is most effective to encourage 35 conservation

37 Assessment of Alternative Pricing Structures Revenue Stability to limit the variability of annual variation in revenues due to fluctuating consumption patterns use of property taxes or flat rates would remove the consumption variability use of base charge providing for a fixed amount to be collected regardless of consumption can also assist fixed costs are usually in the range of 90% of total costs of water/wastewater services Economic Development key objective for many municipalities the decreasing or hump back rate structures assist/attract high volume industries where water is used in production/processing 36

38 Assessment of Alternative Pricing Structures Administration and Implementation pricing Structure can be dependant on ability to support the application of the structure are customers metered is there data on meter sizes, customer types, volumes can billing software support the structure what support is required/available to collect/analyze data is staffing available for billings, customer enquiries, A/R, collections, etc. 37

39 Assessment of Alternative Pricing Structures Evaluation Checklist Goal Property Tax Flat Rate Constant Rate Increasing Block Rate Decreasing Block Rate Hump Back Rate Base Charge Special Rates Ease of Administration H H M M M M M L Simplicity M H H M M M H M Equity L L H M M M M H Revenue Stability H H M M M M H M Conservation L L H H M M L H/M Economic Development M M M L H H M M/L Implementation H H M M M M M L H=High M=Medium L=Low 38

Water and Wastewater Budget development Summary of proposed 2015 Water and Wastewater rates About demand forecasting

Water and Wastewater Budget development Annual operating budget development for water and wastewater is based on net zero funding principles, as defined by the Municipal Act, 2001, where revenues and expenses,