By Erin Boeke Burke
What Does “Affordable” Mean?
There are a wide range of opinions on what it means for water and sewer service to be “affordable.” To some, water is a human right, others a property right, and still others a commodity. One thing is certain: Access to potable water is not free, because the infrastructure to access it, properly and safely treat it, and deliver it to the end user is not free. The question for decision-makers such as utility managers and rate regulators, then, is: If not free, then how much should it cost? There is no clear answer, nor are there universally accepted benchmarks.
Regardless of the utility’s service area economy, the relative ability of its customer base to pay the utility bill has remained important to the sector itself. Whether the customers are affluent or not, highly residential or less so, experiencing rapid growth or more stable, examining rate affordability gives an idea of how much flexibility a utility has to increase its operating revenues. In the parlance of environmental, social, and governance (ESG) investment considerations, affordability constraints are a social risk, but strong governance can mitigate them.
How Does Affordability Affect Ratings?
Not only is affordability one of many inputs into a utility manager’s business decisions, but it is also a relevant credit factor. Under S&P Global Ratings’ criteria for assessing the creditworthiness of water and sewer utilities, we give equal weight to our opinion of enterprise risk as to the financial risk. We assign each utility a “market position” score based on our opinion of the relative affordability, comparability of rates with those of peers, and management flexibility to increase rates in the future if additional revenues are required to maintain financial strength. This market position score represents 25 percent of the enterprise risk profile.
Our market position score starts with the average household bill as a percentage of median household effective buying income (MHHEBI), and the county poverty rate. The relative poverty rate is important because service areas that have not just lower MHHEBI levels, but also disproportionately higher percentages of the population located in the lowest quintiles of the MHHEBI distribution curve, may exhibit greater sensitivity toward perceived affordability. This two-pronged approach should feel familiar to people who read the AWWA, NACWA, and WEF report “Developing a New Framework for Household Affordability and Financial Capability Assessment in the Water Sector,” published in April 2019. The committee may also adjust the score for utilities that have recently completed a historically capital-intensive period, if a utility is in a period of substantial rate increases, or it otherwise thinks that future rate-setting flexibility may be more constrained. Signals about other constraints may include elevated levels of nonpayment or customer shut-offs, or significant customer or political opposition to proposed rate increases.
What About Rate Structure or Affordability Programs?
Individual utilities will have different priorities in terms of conservation signals, revenue stability and affordability. In general, our criteria for creditworthiness are agnostic as to rate structure, but we will consider whether the utility is able to consistently post strong financial results and adjust rates to reflect rising costs or changes in weather or conservation patterns. This also applies to affordability programs; S&P Global Ratings does not think that affordability programs directly contribute to creditworthiness nor does it have a bias toward or against specific types of programs. However, depending on how a program is implemented, that may affect our view of the overall creditworthiness of a utility.
Well-constructed affordability programs can improve revenue certainty and stability by helping reduce delinquency and nonpayment rates, and manage political opposition to rate increases for customers that a utility has determined to have a stronger ability to pay. Efforts to increase water and sewer rates are often met with the strongest opposition by people on low or fixed incomes, including retirees. By providing programs to help customers with the greatest constraints, these efforts could reduce resistance to rate increases on others, provided the size of the differential does not get too extreme or raise questions about the cost of service.
However, attempts to introduce an affordability program can also create additional risks. Depending on the number of customers who qualify for financial assistance and the size of the benefit, program costs (appropriated costs or foregone revenues) could exceed projections to the detriment of system net revenues. Any attempts to introduce a program could face similar public opposition as rate increases often do, causing lawsuits and revenue uncertainty for extended periods. More complicated rate structures can also lead to customer confusion and increase the likelihood of administrative errors.
What Lies Ahead for Water and Sewer Rates?
In general, water and sewer rates at rated utilities are still at levels that we consider affordable. In our 2018 survey, “Affordable for Now,” only 2 percent of utilities had market position scores of “vulnerable” or worse. We acknowledge that this is not a random sample, as we only maintain rate data on utilities associated with public debt. Due to the nature of this sample, these utilities will generally be larger and have greater financial capacity than the universe of all municipal water and sewer utilities in the United States. Affordability may be a significantly more pressing issue for other utilities; we noted in our survey results that rates tended to be higher at smaller utilities unable to take advantage of economies of scale.
However, rate inflation in the sector has been higher than in many other utility sectors, and we expect this trend to continue. In time, declining public funding and additional debt financing for capital needs will push more system costs onto ratepayers. We believe that affordability, particularly for low- and fixed-income residents, could come under pressure and constrain revenue-generating flexibility as public utilities work through large capital plans due to aging infrastructure, changing regulatory requirements, and concerns about securing long-term water supply. Affordability of steadily increasing rates and charges to the customer remains an area that we will continue to watch closely. We believe this could be the biggest key to rating stability.
Erin Boeke Burke is associate director, municipal and cooperative utilities, with S&P Global Ratings. She joined S&P Global Ratings on the U.S. Public Finance team in 2016. In this position, she rates public utilities as well as debt issued by State Revolving Funds and bond banks, and has done several Green Evaluations in U.S. Public Finance. She previously worked for the federal Office of Management and Budget in Washington, D.C.
