Accounting for Residential Nonpayment Risk for Water Utility Financial Sustainability

Abstract

Residential "Nonpayment risk"for water utilities-The risk of revenue loss from residential customers not paying water bills-is a financial risk for water service providers that remains poorly understood. Current rate setting strategies do not explicitly consider nonpayment risk and are generally informed by past payment histories. We develop a new heuristic model to categorize and evaluate water utility pricing (rate setting) strategies that are responsive to the effects of nonpayment (i.e., delinquency) on water utility revenues. The model is the first attempt, to our knowledge, to theorize the impact of residential nonpayment on utility revenues. The method draws on the theory behind the Kelly Criterion, a strategy developed in the mid-20th century now used by investors in portfolio management. The results of our thought exercise show that even excessive nonpayment levels (50% each year) do not negate the effectiveness of rate increases for revenue generation, but that nonpayment management can provide revenue benefits. Without political motives, utilities with high nonpayment may be inclined to continue raising water rates, unless higher water rates result in higher nonpayment levels. As such, we highlight the need to understand "nonpayment elasticity": The change in nonpayment due to changes in water rates. We illustrate how increased nonpayment elasticity can decrease the percent of potential revenue collected, particularly when water rates are increased substantially. The simple model provides a method to evaluate the financial sustainability of elevated nonpayment rates in water utility management and financial risk analysis.