Many people across the U.S. turn on their faucets and flush their toilets without a single thought about how the water got there or where the sewage is going. When it comes to their increased water and sewer bills, however, they have many thoughts. Unfortunately, water and sewer providers are not immune to the ubiquitous nature of inflation—utility providers’ costs for operations and maintenance continue to rise. The main way utilities deal with this is through raising user rates. Act 605, passed by the Arkansas Legislature in 2021, addresses some of the issues around the rising costs of repairs and upgrades necessary to maintain compliance with federal and state law, and operate water and sewer utilities in a safe and effective manner that complies with the Clean Water Act.
Lower utility rates may be an indicator that a utility has not charged enough for their commodity or their service and lacks crucial operating funds. Many utilities have needs that cannot be met on current annual budgets. Rising material costs, increased regulatory requirements, cost of living for staff and systems that have reached the end of their projected useful life can culminate with the potential to bankrupt smaller systems that are already operating on the edge of solvency.
Act 605 requires most water systems in Arkansas to provide additional information about the rates they charge customers for their services and how user rates are developed. The schedule for compliance began July 1, 2024, for systems with 500 or fewer customers and allows systems with more than 1,000 customers until July 1, 2026, to complete the requirements. Thereafter each system shall update their information every five years. The rule was updated with Act 545 of 2023, which removed the requirement for a project-specific rate study under certain conditions.
WHAT ARE THE REQUIREMENTS OF ACT 605?
It is common for municipal utilities that operate a water and sewer system to perform the study on both systems to ensure financial health. If a municipality operates their sewer system jointly with their water service, both systems are subject to the requirements of Act 605. Since this is the first time that utilities have had to provide this reporting to the state, there has been a learning curve about the American Water Works Association (AWWA) Manual M1, Cost of Service Rate Making process. The information required includes a comprehensive financial analysis from a pre-qualified firm, an asset inventory, management plan, capital improvements plan, recommendations on operational adjustments and a proposed rate design to meet a minimum debt service. Rate studies must be provided by a pre-qualified firm.
Act 605 also requires some reporting about asset locations relative to the system boundary, some workforce recruitment and retention information, and a requirement for the utility system leaders to participate in Act 605 compliance training. Failure to comply with the rule with result in the utility being put under the designation of fiscal distress. When a utility is under fiscal distress, they will no longer receive state financial assistance outside of emergency situations.
HOW ARE A SYSTEM’S OPERATIONS AND MAINTENANCE COSTS EVALUATED?
Past data from the system is used as a starting point to perform a rate analysis and determine if revenues have previously been adequate to perform required maintenance. If the system does not have enough money in the bank to perform the requirements of day-to-day operations and anticipated routine maintenance and equipment replacement, then the system is likely not charging enough for the service.
Determining the amount of money that the city is required to collect and save to support debt service is an integral part of the financial analysis. The asset inventory is a record of all physical pieces of the utility system and anything else that costs money to maintain or replace. This record is required to identify a system’s value and maintenance costs and provide a plan for replacement of essential assets. This process will quickly identify if a system has been generating adequate revenues to support the ongoing operations and maintenance of the system. If the system is not generating enough revenue, Act 605 requires rate adjustments that will allow the system to generate positive revenue to meet its operations and maintenance needs.
HOW ARE NEW RATES DEVELOPED?
With data provided from the asset management inventory and plan, a financial rate study is performed to evaluate the costs incurred by the utility to provide drinking water and sewer service to customers. All costs integral to the system’s ability to provide reliable service to the customer are included. The results of the study will show if the annual cost of providing the service is more or less than the annual revenues generated/collected by the utility. As noted above in Figure 1, there is a requirement to maintain a certain debt coverage ratio to cover repair and replacement costs.
The collected data allows a recommendation to be made about if and how much to increase user rates. Unfortunately, it is most often the case that a recommendation is made to increase rates. However, this is no surprise when considering all the individual cost increases for the parts of the system and that these costs must be covered by user charges. Typical recommendations include rate increases over one to five years, with individual annual increase amounts planned based on need. For systems that are required to raise their rates more than 50%, additional time is allowed. Example: Year One 30%, Year Two 10%, Year Three 3%, etc.
Additionally, the AWAA Manual M1 recommends other specifics for consideration by the system leaders. One example of this is the recommendation to not include any water in the minimum monthly service charge for each customer. While this is not the norm in Arkansas, it is one specific detail of the nationally recognized way of creating equitable rates. The AWWA has been a reliable authority for guiding water professionals in how to establish fair and equitable rates since the first M1 Manual in 1954.
WHY IS ACT 605 SIGNIFICANT?
Act 605 has come too late for some utilities that have been consolidated with an adjacent financially healthy utility. Small systems are more financially vulnerable due to their historical reliance on state and federal loans or grants. The users of the system have never borne the full costs, since the upfront construction costs were low- or no-interest financed loans or grants. Without funds to cover repairs and replacement coming from the state or federal government, systems are being faced with a greater financial independence and must adapt by generating enough revenue to keep their systems operating efficiently and effectively.
Ultimately, Act 605 is targeted at helping individual water systems become financially healthy. Other programs can also become more important if the new user rates are a burden to low-income users. Operations and maintenance of water and wastewater works, including repair and replacement of infrastructure, is at the heart of why Arkansas legislators decided to act and pass the new law in 2021. Act 605 may be the most important legislation ever passed by Arkansas for long-term maintenance of our drinking water systems.
