Supplementary memorandum submitted by
Ofwat (Ofwat 09a)
In the session the Committee asked about a quote
taken from your submission to the Committee, but we were unable
to provide the reference for it. The quote was "We will not
make price limit allowances where we have discretion and where
there is no evidence of willingness to pay", and was from
paragraph 34 of your submission. It would be helpful if you could
provide an explanation of the quote.
Companies submit a range of investment proposals.
Some of these are statutory and we are obliged to make an allowance
which will allow the company to deliver the expected outcome.
We will consider the proposals very carefully and our price limits
will reflect what we consider to be the efficient costs of putting
in place the best value solution. For proposals to invest that
do not have a statutory basis we will consider what customers
think about them. We will take account of the results of cost
benefit analysis (which includes willingness to pay research)
and our wider consumer research as we make decisions on what outcomes
to include and what price limit allowance to make.
What impact does Ofwat assume that metering has
had on reducing per capita water consumption?
Water companies generally assume that compulsory
metering will lead consumers to use around 10% less water, on
average, based on evidence from the Isle of Wight metering trial
in the late 1980s. Consumers who choose to have a meter, on the
other hand, tend to use less than the average amount already.
They opt for a meter because they can save money even without
reducing their water use. Nevertheless, optants do still cut back
on their use, but the reduction is more likely to be around 5%.
Anna Walker explained to us that there is a tipping
point in relation to metering—around 60-70%—when running
two charging systems has its own costs and those households remaining
unmetered are paying a lot more. What assessment have you made
about the point at which it is sensible to introduce compulsory
metering in an area, and how should such a transition be managed?
Most companies have three "charging systems"
for household customers—metered charges, RV-based charges
and assessed charges. Operating these different charging systems
has an impact on billing costs at any level of meter penetration
below 100%, but that impact is relatively modest and unlikely
to be a determining factor in the case for universal metering.
The increase in unmetered bills as meter penetration
increases is a separate point. As discussed above, unmetered customers
tend to opt for a meter when doing so saves them money. That is
more likely to be the case when they have high rateable values
and relatively low water use. As these low-use customers switch,
the average water use of the unmetered customer base increases.
Our regulatory mechanisms make sure that charges for unmetered
customers reflect the average water use of unmetered customers
as a whole. So when average unmetered use increases, unmetered
charges increase too. In the extreme, if there were just one unmetered
customer remaining, (s)he would pay an amount that closely reflected
the amount of water (s)he used. We think that this system is fair.
The case for compulsory metering, then, is not
based on the balance between metered and unmetered charges at
different levels of meter penetration. Rather, it is based on
the costs and benefits of metering at a faster pace than would
occur with the steady trickle of meter optants. We expect companies
to take account of all of the costs and benefits, whether direct
or indirect, when they make this assessment. For example, they
should take account of any investment in water supplies that they
can avoid as a result of reducing consumer demand through metering.
And they should consider the energy and carbon savings that consumers
will achieve when they use less water, bearing in mind that consumers
would have heated some of the water that they are saving.
We have been told that bad debt (non-payment of
water bills) adds £11 to the average bill. What analysis
has been done of the relative proportion of "can't pay"
and "won't pay" that makes up bad debt. Have you conducted
any analysis of how the average bad debt £11 figure would
be reduced if social tariffs were widely available?
It is correct to note that currently bad debt
accounts for around £11 per household customer per year.
This includes approximately:
— £3 to cover financing costs associated
with outstanding revenue.
ANALYSIS OF
CAN'T
PAY AND
WON'T
PAY
It is often difficult distinguish between "can't
pays" and "won't pays". There is a lack of precise
data on this issue. However there is a range of research which
gives some insight into the characteristics of those who do not
pay their bills.
The distinction between "can't pay" and
"won't pay" is not always clear—there is often
also a "struggling to pay" category (for example, see
Dominy and Kempson's paper[3]
which analyses in detail the characteristics of debtors who can't
and won't pay). Research commissioned by WaterVoice (CCWater's
predecessor) and Ofwat in 2003 found that customers with water
debts could be divided into three main groups—those who
take the line "why should I pay", those who are genuinely
struggling financially and those who are poor money managers.
As water companies supply their customers under
a statutory duty rather than a contract they may have limited
information about their debtors. Determining whether these customers
are "can't pays" or "won't pays" on a case
by case basis can therefore be difficult. However more companies
are now purchasing data from external agencies and visiting debtors'
homes in order to gather information and understand more about
individual circumstances. This allows them to tailor their collection
processes appropriately, using a sensitive approach for those
with genuine payment problems but taking a firmer approach to
the "won't pays". We fully support this differentiation
and endorse this approach in our guidelines to the sector on dealing
with customers in debt.
To help address this gap in the water companies'
knowledge in 2004 UKWIR commissioned research[4]
to understand the characteristics of those who were in debt to
their water company. The research was updated in 2006[5]
and attempted to quantify the scale of the debt problem associated
with the high-risk groups.
A number of companies have undertaken research
in order to understand more about their debtors. However, the
results vary, with some stating that most of their debtors are
genuinely struggling to pay whilst others reporting more of a
mix.
Ofwat collects data on the age of revenue outstanding
(and corresponding number of households with revenue outstanding).
This shows that over time the older debt age bands have increased
most. In 2008-09 1.4 million households were reported as owing
water charges for over two years. Many companies tell us that
although they are improving their management of recently billed
charges, they have a hard core of debtors who persistently fail
to pay. As companies undertake a range of activities to collect
debt, including court action and outsourcing to debt collection
agents, it could be hypothesised that those with longer term debts
are more likely to be those in genuine difficulty.
WHAT CAN
BE DONE
TO REDUCE
THE £11 COST
OF DEBT
Ofwat applies strong incentives on companies
to manage their revenue collection and other operations effectively
and efficiently so as to minimise the cost to those who do pay
their bills. The sector as a whole is expected to continue becoming
more efficient over time and individual companies are expected
to catch up towards the best.
We expect companies to make it as easy as possible
for customers to pay their bills, for example by offering a range
of payment arrangements to suit different customers' needs. We
also expect companies to provide advice to customers on how to
make their bills more manageable, for example fitting meters and
offering water efficiency advice for those who would benefit.
Whilst social tariffs can be very beneficial
for those customers qualifying for them, the £11 would not
be reduced by a significant amount by their extension.
It is not possible to say by how much the figure
could be reduced if social tariffs were extended as this would
depend on a number of factors, including the qualifying criteria,
level of take-up, level of savings and how the costs were rebalanced
(if they were funded by other customers). Any significant changes
to tariffs would produce winners and losers.
Customers are reluctant to cross subsidise others.
Research carried out by CCWater in association with Ofwat[6]
showed that customers thought £1 per year in their bill to
subsidise a social tariff supporting metered customers in receipt
of certain benefits and either classed as a large household or
where someone has a medical condition requiring additional water
use (ie WaterSure) was reasonable. Support decreased for larger
amounts of subsidy. 39% would support it increasing to £2,
19% would support it increasing to £5, but only 3% would
be content to pay over £10 to subsidise other groups of customers
such as pensioners on fixed incomes, disabled or low income households.
Most customers felt that help should be provided through the tax
and benefits system.
Ofwat considers that protection for customers
should be provided by Government, either through the benefits
system or through specific, targeted (and transparent) social
transfers in tariffs specified in regulations. One such tariff
"WaterSure" has already been put in place to protect
vulnerable metered customers from higher than average bills.
Whilst Ofwat does not support the introduction
of social transfers through the water and sewerage charging system,
we have supported companies wishing to provide help to specific
groups of customers where this is also expected to reduce the
effect of debt on the generality of customers (ie win-win). A
number of tariffs are currently being trialled. Some offer customers
financial incentives to sign up to more effective payment methods.
Others provide reduced bills for customers in hardship, on the
understanding that they are more likely to pay a lower bill rather
than default on a higher one. These trials are expected to be
self financing, with improved revenue collection and reduced debt
recovery costs more than offsetting the administration costs and
reduction in bills to participating customers. Early indications
from the trials are promising but it is too early to say whether
they will reduce the bill on the generality of customers, and
if so, by how much.
In our response to the Walker Review Call for
Evidence we included analysis which indicated the potential level
of bill increase that customers could face in providing an annual
£100 discount in charges for a social tariff (assuming the
cross-subsidy is contained within the water and sewerage sector).
These increases could range from around £1 to help customers
currently spending more than 8% of their income on water charges
to £50 to help all pensioners and single parents (please
see our response for further detail).
Could you explain how you have incorporated Sir
Michael Pitt's recommendation that "longer-term resilience
building is expected to be formally integrated into the periodic
review cycles of the economic regulators" into the Price
Review?
In our methodology paper, which set the framework
for the periodic review, we asked each company to specifically
review resilience of its critical infrastructure to surface water
flooding and how it will meet the challenge of supplying consumers
in extreme situations. We further supported companies by producing
an analytical framework for assessing resilience to help water
companies understand, and mitigate, the risks to their critical
infra-structure. We have made it clear to companies (in PR09/12)
that we expect that resilience should to be improved over time
in a phased, transparent and systematic manner.
As noted in your evidence session, the UK climate
change impact predictions are delayed. Could you let us know how
the Price Review process will incorporate those climate change
predications once they are published?
We would anticipate a full and proper review of the
UKCP09 scenarios would take longer than the current price review
process. In recognition of this we are providing companies with
a mechanism to propose significant investments necessary to balance
water supply and demand based on UKCP09 scenarios during AMP5
(2010-15).
We expect companies to use UKCP09 scenarios to understand
the wider impacts on all their operations. This new evidence base
should be used to inform long-term strategies to adapt to, and
mitigate the effects of, climate change beyond this current price
review process.
How much did it cost Ofwat to run the previous
two Price Reviews, and how much do you expect PR-09 to end up
costing? Do you have any data for how much Previous Reviews or
PR-09 cost the water companies (or if no data available, do you
have an approximate estimate)?
From the Ofwat Resource Accounts (Schedule 5)
the best estimates of the last price reviews are:
— PR99 £4.1 million
— PR04 £6.1 million
It should be noted that these are ball park
figures.
A rough estimate based on the same proportions
of total expenditure applied to PR09 is circa £7.7 million.
We will have a clearer a view of the cost of PR09 after we have
conducted a review of the price review.
We do not have figures readily to hand for how
much the price reviews cost the water companies. We could provide
this information after draft determinations at the end of July.
Alternatively you might be able to get this information from the
water companies.
Defra has told us that "As part of PR09,
Ofwat is developing a Change Protocol. This provides a mechanism
for water companies and Ofwat to take account of significant factors
that may arise during a price review period which are identified
or defined too late to be included when water price limits are
determined. This will enable, for example, relevant outcomes from
the Cave and Walker Reviews and any relevant legislation in the
forthcoming Flood and Water Bill, to be addressed before the next
price review." Could you provide a description of the Change
Protocol and explain how it will work, including how it would
cater for changes arising from Cave, Walker or the Bill?
The change protocol, which is not new, is an
important part of the framework for regulating water prices to
ensure value for consumers.
Ideally, when we set price limits we would have complete
certainty over what companies will need to deliver during the
next five year period and the resulting implications for customers.
Experience has however shown that new outputs will inevitably
arise which could not be foreseen or taken into account in sufficient
detail when price limits are set. Such outputs, which can arise
from new statutory obligations, new scientific evidence or changing
customer priorities, cannot always be offset by related counterbalancing
changes in company investment programmes. We therefore need a
mechanism for taking the financial implications of these changes
into account, other than when they are minor.
The change protocol sets out a process for companies
to follow in seeking financial recognition of new outputs, should
they wish to do so. Companies can use this process when, for example,
they have to undertake work within the price limit period in order
to comply with new changes to environmental or drinking water
standards. It is important to note that the change protocol is
without prejudice to the need for companies to comply with new
statutory obligations. It is concerned only with the financial
recognition of changes to the requirements assumed in price limits.
In setting down the process that companies have
to follow in providing supporting evidence to us on the need (or,
if non-statutory, customer support) for the proposed actions,
along with scope and cost, the change protocol ensures that we
apply a similar degree of scrutiny and challenge on behalf of
customers as at full price setting.
Use of the change protocol usually results in
a request for logging up (or logging down, where expected outputs
no longer apply), whereby the financial implications are taken
into account at the beginning of the next price limit period.
However, in certain clearly defined circumstances set out in company
licences it can result in a revision to price limits during the
current period.
Possible drivers for change protocol submissions
during the next price period include further work arising from
the Water Framework Directive, finalisation of Water Resource
Management Plans, emerging evidence on climate change impacts
and the transfer of private sewers. These outputs cannot currently
be defined in sufficient detail for PR09.
I hope you find this information useful and
please do let us know if there is anything else we can help with.
Ofwat
June 2009
3 Nicola Dominy and Elaine Kempson, "Can't pay
or won't pay?: A review of creditor and debtor approaches to the
non-payment of bills", March 2003. Back
4
Water Industry Debt-Socioeconomic and Demographic Effects (04/CU/04/3).
This used postcode level information to provide a sociological
overview of debtor types. Back
5
UKWIR Report reference number 06/CU/04/4 "Quantifying different
types of water industry debt" (2006). Back
6
ORC International, "CCWater Charging Research 2007"
(April 2008). Back
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