Wilderness Rim Association Water Rate and Reserve Study Board Meeting April 23, 2014

1. Wilderness Rim Association Water Rate and Reserve Study Board Meeting April 23, 2014 Presented By: Chris Gonzalez, Project Manager

2. Agenda • Overview of Utility Rate Making • Discussion of Utility Financial Policies • Sources & Uses of Funds • Utility Reserve Structure • System Reinvestment (Funded by Surcharge) • Financial Performance Standards • Summary of Financial Forecast & Rate Strategy • Questions/Discussion

3. Introduction to Utility Rate Making • Utility rates are set to recover the cost of providing service • Utilities incur two primary types of costs: • Operating costs (regular/ongoing) • Employee salaries and benefits • Power and chemicals • Asset repair and maintenance • Capital costs (inconsistent/limited) • Infrastructure replacement • Facility expansions and upgrades

4. General Methodology 1. Establish Policy Framework 2. Forecast Revenues 2. Forecast Expenses 3. Define Rate Revenue Requirement

5. Policy Framework Fiscal policies provide a sound basis for financial management of a utility, addressing various topics including (but not limited to): • Sources & Uses of Funds • Utility Reserves (Structure & Levels) • Rate-Funded Capital Reinvestment • Financial Performance Standards

6. Sources & Uses of Funds • The water utility is an “enterprise” • Water rates are set based on the cost of providing service • Water utility costs are funded by water utility revenues, without support from the General Fund or assessment revenues • The utility maintains a separation of capital and operating resources/expenditures • Current budget reflects an allocation of surcharge revenue to the Water Reserve (for capital) • Revenue from water sales and other operating revenues must fund the cost of system operation and maintenance

7. Utility Reserve Structure The Association maintains a separate ‘Water Reserve’ for capital expenditures. Potential purposes for this reserve include:

8. Considerations for Sizing Water Reserve • Potential exposure to financial liability • Regulatory changes (e.g. water quality or fire flow standards) • Other capital investment needs identified in Water System Management Plan • Accumulating infrastructure replacement liability • Availability of other funding sources • Limited access to external funding can justify a larger fund balance • Potential impacts to ratepayers • Reserve funding comes from monthly surcharges imposed on customers (currently $8.00 per bimonthly billing period per customer)

9. Other Utility Reserves Other common reserves not currently in place for the Water Utility: • Operating Reserve • Intent: Manage short-term fluctuations in revenue and expense cycles • Benchmark: 30 – 45 days (8 – 12%) of budgeted operating expenses • 2013-14 Budget  Target balance of $19,500 – $29,250 • Rate Stabilization Reserve (Not Funded In This Study) • Intent: Protect against revenue loss during low-sales years • Benchmark: 20 – 25% of annual rate revenue • Goal: Cover a 10% revenue shortfall for up to 2.5 years • 2013-14 Budget  Target balance of $42,300 – $52,900

10. System Reinvestment • The Association’s water rates are set to cover the cost of system operation and maintenance • Funding for asset replacement is an important part of a long-term rate-management strategy • Infrastructure replacement can be costly • Deferred maintenance also has costs • Potential benchmarks for annual system reinvestment funding • Depreciation expense (based on original cost) • Depreciation expense (based on replacement cost) • Sinking fund (based on anticipated needs)

11. System Reinvestment: WRA Example • Assumptions: • Cost of original water system (1986): $247,061 • 50-year useful life  replace original water system in 2036 • 3% annual cost inflation  estimated 2036 replacement cost = $1.3 million • 1% investment interest rate • 2013 Reserve Balance: $502,937 • Projected 2014 – 2019 capital expenditures: $75,510 • Potential benchmarks for annual system reinvestment funding: • Original-Cost Depreciation: $247,061  50 years = $4,941 • Replacement-Cost Depreciation: $4,941 × (1.03)Asset Age • Sinking Fund: $27,382 Annual transfers escalate with inflation, ranging from $10,983 – $21,677 per year Annual transfer needed to fully cover projected replacement cost in projected year of replacement, given other projected expenses

12. System Reinvestment: WRA Example Cash Accumulated for Replacement of Original Water System Replacement Cost in 2036: $1.3 Million Replacement-cost basis funds ≈ 81% of replacement liability System reinvestment policies intend to generate a reasonable level of cash funding, considering near-term financial impacts. Original-cost basis funds ≈ 52% of replacement liability

13. WRA Surcharge for System Reinvestment • The Association currently charges its customers a bimonthly surcharge of $8.00 per account • Projected to generate ≈ $31,000 per year • 2013-2014 Budget: Revenue goes to reserve for capital • Annual transfer of ≈ $36,000 would be needed to cash-fund replacement of all current water system assets • Based on projected infrastructure replacement needs, assuming that assets need to be replaced 50 years from their acquisition date • Relies on available water system asset records and assumptions (see previous WRA system reinvestment example) • Would equate to a bimonthly surcharge of ≈ $9.30 per account

14. Financial Performance Standards • Goal: Water utility generally maintains non-negative cash flow • Water revenues are adequate to cover the water utility’s expenses • Short-term deficits may be allowed as part of a multi-year rate strategy • Goal: Maintain reserves at or above targeted levels • Rate studies should plan to meet reserve targets • If a reserve’s balance falls below its target level, the Association should plan to replenish it over several years • Goal: Comply with financial performance requirements established by debt agreements • Not currently (or expected to be) an issue for the Association • May become an issue if the Association needs to secure external financing (e.g. bank loan) to fund capital projects

15. Revenue Forecasting • Other Operating Revenues: • Based on FY 2013-14 Budget (with no growth) • Late Fees: $10,500 • Transfer Fees: $2,000 • Lock/Reconnect Fees: $1,000 • Surcharges: • Estimated based on customer statistics and prevailing surcharges • Water surcharge ($8.00 per billing period) – ongoing • Reserve study surcharge ($1.34 per billing period; expires in mid-2016) • Water Sales: • Based on estimated FY-2013-14 sales revenue and prevailing water rates • Assumes no growth

16. Expense Forecasting • Administrative Costs: • Water utility’s allocation based on FY 2013-14 Budget • Increased to reflect WRA’s assumption of billing responsibilities as of Jan 2014 • Labor costs increase by 2.5 – 4.0% per year; other costs increase with inflation (1.7 – 2.5% per year). • Sallal Water Purchases: • Based on FY 2013-14 Budget • 4% increase for FY 2014-15 negotiated with Sallal • Assumed to increase by 3% per year beyond FY 2014-15 • Sallal O&M Contract: • Based FY-2013-14 Budget, reduced to reflect WRA’s assumption of billing responsibilities as of Jan 2014 • 4% increase for FY 2014-15 negotiated with Sallal • Assumed to increase by 3% per year beyond FY 2014-15 • Water Reserve Transfers: • Reflects transfer of surcharge revenues to reserve • Other Water Operations: • Based on FY 2013-14 Budget • Assumed to increase with inflation (1.7 – 2.5% per year)

17. Capital Needs Forecast • Capital Costs Through 2019*: • Sampling Stations: $37,250 • Hydrant Modifications: $9,403 • Meter Replacements: $5,321 • Water System Plan Update: $32,939 • Total: $84,913 • Planned Funding Strategy: • $84,913 in cash funding from existing Water Reserve resources and surcharge revenue *Reflects adjustments for future cost inflation at ≈ 3.2% per year

18. Water Revenue Requirement Analysis • Revenue at existing rates is insufficient to fully cover costs • Partially due to increase in allocation of admin costs to water utility • Driven by assumption of meter reading/billing duties by WRA • Operating deficit is expected to grow as costs increase over time • Recommended financial policies also have an impact… • Water utility does not currently have an operating reserve • General Fund operating reserve can be used in emergencies • Goal is for the water utility to be self-sustaining • Assumed $71,000 interfund loan from the Water Reserve • Funds water utility operating reserve and enables the phasing of rate increases over several years • Balances recommended “sources and uses” and “financial performance” policies with near-term financial reality

19. Water Utility Financial Forecast Alternative: Upfront rate increase of ≈ 28%

20. Recommendations • Establish a separate operating reserve for the water utility • Consider establishing a rate stabilization reserve as resources allow • Provides protection against revenue risk resulting from low-sales years • Maintain surcharge of $8.00 per month per account • Continue to allocate surcharge revenue to the Water Reserve • System reinvestment is an ongoing need  consider integrating into the “basic” water rate (rather than as a separate “surcharge”) • Increase water rates by 9% for FY 2015 • Review utility rates annually