Finance your system

Local governments are the primary investors in water infrastructure. Operating water utilities as financially independent enterprises ensures this extensive and critical system has the appropriate resources available to repair and replace infrastructure in a timely and cost-effective manner. The following section outlines best practices in setting fair and viable water rates, and options for utilities to finance capital improvement projects to ensure your community’s drinking water system remains safe and sustainable.

The Illinois-Indiana Sea Grant Program
in partnership with the Chicago Metropolitan Agency for Planning and the University of Illinois Extension, developed a Full-Cost Water Pricing Guidebook specifically for community water systems in Northeastern Illinois. The guide is intended to assist local decision makers in setting appropriate water rates to ensure sustainable water service now and into the future.

Go Set appropriate water rates based on cost of service

Unlike water pulled right from a lake or river, treated drinking water provided on demand is a utility service—just like energy and telecommunication. Utilities add value to drinking water through treatment, storage and daily distribution directly to customers in their homes, schools and businesses. Treating and delivering water requires both capital and operating expenditures. As such, pricing this service to ensure the long-term viability of the system and sustainability of the water resource is critically important.

Revenues generated by water rates are, and will continue to be, the primary source of funding for drinking water utilities. Water rates must recover the full cost of operations as well as maintenance and capital costs. Rates should also consider resource depletion (scarcity) and environmental costs. Setting water rates at an appropriate price, and creating an enterprise fund so that water utility revenues are used only for utility operation and maintenance, helps ensure sustainable water service and availability for your community now and into the future.

The need for full cost pricing

Adjusting water rates to match costs

The Alliance for Water Efficiency (AWE)
is a stakeholder-based nonprofit organization dedicated to the efficient and sustainable use of water. AWE operates Financing Sustainable Water, a website which includes guidance, tools and other resources to assist water utilities in ensuring responsible, viable and sustainable water rates and services, now and into the future.

Rate setting is the process through which a water system ensures revenue adequacy. Water suppliers face several decisions about what rate to charge for drinking water service. Rate setting involves conducting a cost-of-service rate study, and should include the following steps:

‍Step 1 Determine cost of service (including operation, maintenance and capital investment)
Step 2 Project revenue based on future demand
Step 3 Design rate structure

But how do I know what to charge?

Following are key considerations each utility/community should consider throughout the rate-setting process:[1]

‍Rates must be set at a level that covers all of the costs to finance, produce, treat, store and distribute water to customers as well as provide capital for investment in the water utility system
Rates must be fair and equitable
A water system’s revenues should not be used to pay for other municipal services or needs
Customers should easily understand their water rate
The rate structure should be easy to administer and be reviewed once a year
Good rate structures are based on accurate financial information and customer records
Affordability programs for economically disadvantaged customers need to be established

No elected official wants to raise rates. However, the long-term viability of a community’s drinking water system is essential to its sustainability. If rates are reviewed annually as part of the budgeting process, they can be adjusted in small, annual increments instead of infrequent, but large, increases. This is much more palatable for customers over time. A hallmark of sound ratemaking includes basic principles of transparency[2]—customers should easily understand the intent and purpose of a good rate. Given the extent of infrastructure requiring repair and replacement today and in the near future, putting off setting appropriate water rates puts a community in jeopardy.

Case study

Water rates that work

The Village of Algonquin, Illinois has been a leader in water conservation. However, reduced consumption has also reduced revenue. The decrease in revenue, plus the fact the Village had not raised rates in a few years, led the Village to conduct a water/sewer rate study. In January 2016, Algonquin approved an increase in water and sewer utility rates, effective November 2016.

A comprehensive water and sewer rate study evaluated capital infrastructure needs (supply, treatment, storage, distribution and control), decreases in usage and funding and increased regulations. The new rate includes a fixed fee of $10 per billing cycle and an increase in consumption charges each year. The new fee structure also retained a water conservation measure, which triples the rate if consumption is over 20,000 gallons. The decision was to charge a flat fee to ensure enough revenue to help cover general maintenance and operations costs of the system while also maintaining water conservation efforts to ensure that water is available for many years to come.

A note on water rates and affordability: Water rates are on the rise; many customers are seeing increases in their water rates. The reasons are many—water system infrastructure reinvestment needs, the increased costs of treatment and pumping, demand outstripping supply, regulation, etc. What we pay for drinking water is significantly less than what the average consumer pays monthly for cable television, cell phones or even coffee. However, it is important to address emerging affordability issues for vulnerable populations in your community.

Low-income households may face affordability problems if prices continue to rise. In order to avoid and alleviate these hardships, communities can offer equitable pricing structures that mitigate impacts on low-income households such as tiered rates and affordability programs for those demonstrating need. Your utility should be implementing best practices to ensure everyone in your community is appropriately provided for.

Go Finance your capital improvement needs

Without reliable drinking water infrastructure, communities cannot maintain quality of life, economic vitality or a healthy ecosystem. Feasible funding streams to replace and upgrade outdated public water systems are critically needed. Good asset management, regularly updated capital improvement plans and appropriate water rates are critical to understanding what investments your drinking water infrastructure may require in any given year.

But where will the money come from to finance the upfront costs of infrastructure investments? To be sure, there is no one-stop shop for financing our water infrastructure needs. However, there are a variety of options for municipalities to finance drinking water infrastructure upgrades or replacement. The following options are viable ways to finance drinking water infrastructure investments; it is important to note that revenue will still need to be generated from local water rates in order to leverage and eventually pay off these financing options.

Municipal bonds

A municipal bond is a bond issued by a local unit of government to pay for public projects such as roads, schools, and water, wastewater and stormwater infrastructure. Bonds are not a revenue source; they are a means of borrowing money. Bonds allow expenditures—such as capital improvement projects for drinking water systems—that exceed a local government’s annual resources.

If a community is considering issuing bonds to pay for drinking water infrastructure projects, it must evaluate how much money is needed over what time period, and identify how the bond holders will be paid. Municipal bonds may be set up as general obligations of the issuer or secured by specified revenues. Either way, the community must have a reliable stream of future incoming funds to demonstrate its ability to pay back its investors.

In Illinois, additional state tax advantages may be available by issuing municipal bonds through the Illinois Finance Authority’s Local Government Revenue Bond Program. The Illinois Finance Authority also offers a municipal program for non-home rule units seeking to borrow up to $1.5 million for essential purpose public projects through its Local Government Direct Bond Purchase Program.

State revolving fund

The State Revolving Fund (SRF) is a federal, low-interest loan program designed to support water service infrastructure repair and replacement. Each year, Congress appropriates funds to the SRF, and the U.S. Environmental Protection Agency (USEPA) proportionally distributes these funds to each state based on a regular Needs Assessment. Illinois combines these federal dollars with required state matching funds, program repayments, bond proceeds (generated via the Clean Water Initiative bond sales administered by the Illinois Finance Authority and the Illinois Environmental Protection Agency) and interest on loans to generate a perpetual source of loan money for water infrastructure, which the Illinois Environmental Protection Agency (IEPA) administers.

With these SRF funds, the IEPA provides loans for drinking water mains, water meters, pump stations, storage facilities, treatment plants and just about any infrastructure related to a public water supply system through its Public Water Supply Loan Program (PWSLP). During fiscal year 2016–2017, the PWSLP provided just under $500 million in loans to municipal drinking water systems.

If a community in Illinois wishes to apply for a SRF loan, the Illinois Environmental Protection Agency requires the submission and approval of a complete financial package, including a dedicated revenue stream that is adequate to assure loan repayment. Thus, similar to municipal bonds, having a dedicated, established revenue stream is necessary for a community considering an SRF loan to raise capital for crucial infrastructure projects. For more information on how to apply for a State Revolving Fund loan, please see the program webpage on the IEPA’s website.

Public-private partnerships

In addition to bonds and loans, communities can also establish public-private partnerships (P3s) to finance needed drinking water infrastructure improvements. This approach engages the private sector in funding infrastructure projects to meet public service needs. P3s involve the private sector in financing, planning, design, construction, operation, maintenance and/or rehabilitation and replacement of publicly owned infrastructure.

With P3s, a community typically maintains ownership and ultimate responsibility of any infrastructure. The private sector helps finance projects and/or improve cost efficiencies for construction and/or operation and maintenance. P3s may allow for increasing the ability to leverage public funds while minimizing impacts to a municipality’s debt capacity. Like the other financing tools described, P3s require a dedicated revenue stream for repayment.

While there are a number of different ways a municipality can finance its drinking water system, the best approach will vary from community to community. Sound asset management, water rate setting and regularly updated capital improvement plans will allow your community to identify what investments are needed when, and what financing options are the most appropriate.

A number of guides and handbooks outline the basics and best practices for implementing good and equitable water rates as well as guidance on appropriate and advantageous financing for drinking water investment needs. References and links to these helpful resources can be found in the resource section of this guide.

Reduce costs by partnering with your neighbors

Given the rising costs of infrastructure and drinking water service, communities can benefit from partnering through service sharing, joint procurement of goods or services and even consolidation of services. While not a new concept, exploring ways to save your community dollars on drinking water service costs by partnering with your municipal neighbors demonstrates effective governance in a time of scarce resources.

Questions for your staff: Appropriately financing your water system

When was our last rate study conducted? Was the community involved in the process?
Are we considering the full costs of service (operations, maintenance, infrastructure renewal, etc.) in our water rates today?
Are the revenues from our water services put into a separate enterprise fund reserved for water services and maintenance only?
Do we have an affordability program for low-income households?
How are we ensuring sustainable use and equity for customers within our water rate structure?
What is our current municipal debt load/capacity?
Do we have any outstanding bonds for drinking water infrastructure repairs?
Have we ever utilized the State Revolving Fund to finance our drinking water investment needs?
What drinking water investment needs might a P3 financing option be possible?
Have we ever tried coordinating joint procurement or purchasing with our neighboring communities? What drinking water investment needs might lend themselves to that type of coordinated approach that could save us money?

Midwest Assistance Program, Midwest Rural Community Assistance Partnership. Formulate Great Rates The Guide to Conducting a Rate Study for a Water System. Washington DC. 2011.
Midwest Assistance Program, Midwest Rural Community Assistance Partnership. Formulate Great Rates The Guide to Conducting a Rate Study for a Water System. Washington DC. 2011.