Ofwat price review 2009 - Environment, Food and Rural Affairs Committee Contents


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 reflect debt collection costs;

    — £5 to cover bad debts that have to be written-off; and

    — £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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