Financial Mechanisms for Risk Tolerance: Establishing a Dialogue

1. Financial Mechanismsfor Risk Tolerance: Establishing a Dialogue Thomas Pearce Chair, NARUC Staff Subcommittee on Critical Infrastructure Senior Utility Specialist, Public Utilities Commission of Ohio 8 July 2011 Workshop: Risk Management and Economic Regulation for Water and Sanitation Utilities Bogotá, Columbia

2. DISCLAIMER • Nothing contained within this presentation shall be deemed to represent any positions or views of the National Association of Regulatory Utility Commissioners (NARUC), its officers, its staff, its Committees, its Subcommittees, any or all of its individual member commissions, the state of Ohio, its governor, the Public Utilities Commission of Ohio, its commissioners, its staff, nor even those of the author…1 1Remainder of the legal disclaimer: if you’re paying attention, that last item was injected for purposes of humor; it’s okay to laugh and to take neither the presenter nor the presentation too seriously

3. Financial Mechanisms for Risk Tolerance: The Role of the Regulatory Agency

4. What is “risk”? What do we plan for?

5. “A Black Swan”by Nassim Nicholas Taleb • “Ten principles for a Black Swan-proof world” • What is fragile should break early while it is small – nothing should become too big to fail • No socialisation of losses and privatisation of gains • People who were driving a school bus blindfolded (and crashed it) should never be given a new bus • Do not let someone making an incentive bonus manage a nuclear power plant or your financial risks • Counter-balance complexity with simplicity From FT.com April 7, 2009

6. “A Black Swan”by Nassim Nicholas Taleb • “Ten principles for a Black Swan-proof world” • Do not give children sticks of dynamite, even if they come with a warning • Only Ponzi schemes should depend on confidence – be robust in face of rumors • Do not give an addict more drugs if he has withdrawal pains – they need rehab • Citizens should not depend on financial assets or fallible expert advice • Make an omelette with the broken eggs From FT.com April 7, 2009

7. Risk Management • Means different things to different people • May even mean different things to same people, depending upon context

8. Consider These Risks(Pre-/Per-/Post- Event) • Risk Assessment • Risk Mitigation • Crisis Management • Consequence Management • Resource Identification • Actionable Intelligence • Security Support • Notification Processes • Resource Mobilization

9. Financial Mechanisms for Risk Tolerance • Insurance • Financial hedges • Innovative rates or rate tracking mechanisms (trackers) • Others?

10. Rate Tracking Mechanisms • Revenue Decoupling • Disconnect recovery of fixed costs from a variable (volumetric) rate structure • Promotes efficiency • Rate Stabilization • Bad Debt Recovery • Infrastructure Cost Recovery – unaccounted-for or “non-revenue” water leakage often occurs in weakest parts of system and may be more likely to disruption during catastrophic event

11. Emergency Response • If restore to same condition (prior to event), still have same risk (New Orleans, Louisiana); • Incentivize restoration which mitigates likelihood of outage recurrence due to same risk • Shared resources; mutual assistance or mutual aid agreements; WARN – what happens to the costs? How do you recover these “extraordinary” costs?

12. Various Plans • Emergency Response Plans • Priority of restoration plans • Hazard Mitigation Plans • FEMA: mitigation program • Utilities self-assess vs. government agency (provides consistency of evaluation; many operators not properly equipped to self evaluate) • Continuity of Operations Plans • Contingency Plans

13. “Contingency Plans”? • Continuity of Operations Plans? (explain) • Emergency Response Plans? (explain) • Do you review these plans for sufficiency? • Take best practices; ensure robustness? • Are you (government) permitted to define in detail? • Establish requisite guidelines • In US, legislation establishes broad framework • Agency statutes (Administrative Code) give detail • Contents • Review

14. RISK (RIESGO) • We can’t protect against everything • PRIORITIZE • Incentivize investments • Security theater • Shared responsibility • Shared mitigation efforts • Begin with common goals • Incentivize with “carrots rather than sticks”

15. Communication of Risks? • Before an event (normal operations) • Ohio Water Resource Council (government) • Ohio Water Roundtable (with industry) • How do you regularly dialogue amongst yourselves and with industry on these and other issues?

16. Communication of Risks? • During an event (crisis operations) • Government (FEMA, ICS) • Industry (water & wastewater utilities) • After an event • Lessons learned • Modifications to be made moving forward

17. Tabletop Exercises • What are they? • What do they accomplish? • Frequency? • Participants? • Government: federal, regional, local • Industry: utility providers, industry trade associations, other representatives • Establish common goals • Do you conduct them? • Does your organization participate?

18. Resources • U.S. Federal Emergency Management Agency (FEMA) (look for “Tabletop Exercise”) • U.S. Environmental Protection Agency (EPA) • Water Security Division http://www.epa.gov/watersecurity (the “Roadmap Assessment Tool” may be of assistance to small communities/operators) • Tabletop Exercise Tool • NARUC – National Association of Regulatory Utility Commissioners http://www.naruc.org/grants/programs.cfm?page=3

19. DISCUSSION QUESTIONS • Does government have clarity of purpose and approach? • Ministry of Environment, Housing and Territorial Development • Superintendency of Public Services • National Department of Planning • Water and Sanitation Regulatory Commission

20. DISCUSSION QUESTIONS • Do the water utility providers have desire to provide a quality product even more reliably? • Large providers • Small providers • Are you talking with your sector partners regularly to advance common goals? • Are you meeting with each other regularly to advance common goals?

21. COMMON GOALS? • Enhanced outcomes? • Reliability (for example, tank vulnerabilities) • Quality • Partnerships • Crisis communications • Information sharing • Emergency response • Once established, can better determine how to manage risk utilizing various financial tools and rate mechanisms

22. Gracias! Thomas Pearce Senior Utility Specialist, Public Utilities Commission of Ohio Chair, NARUC Staff Subcommittee on Critical Infrastructure +1 614 4661846 thomas.pearce@puc.state.oh.us