Water industry regulator Ofwat has issued new guidance to help companies revise their outcomes proposals as part of the 2014 price review and emphasised the need for the water firms to provide evidence to support their proposals.

Ofwat said a recurring theme across the previous risk-based review testing of companies’ December business plans was that they typically provided explanations of what they proposed, but not the supporting evidence to justify their proposals.

The regulator has reserved the right to intervene in the event that any company is unable – or unwilling – to do this, and put contingency plans in place that will allow it to introduce delivery incentive proposals to safeguard customers.

Introducing the new advice, Ofwat said that in particular, it identifies a number of questions that will help the management team of each company “to consider their own proposals critically” ahead of the submissions of their revised business plans. The regulator said it we will continue “to examine closely” the outcomes the water companies submit in their revised business plans.

The assessment will focus on how well companies demonstrate, together with supporting evidence,  that their proposed incentives deliver on the following seven key ‘themes’:

1. are supported by customers – including evidence that the incentives cover areas that are important to customers, that customers are willing to pay for any reward elements, and that that they can afford to do so;
2. protect customers – including evidence that penalties protect customers against underdelivery, ensuring that companies cannot be better off by choosing not to deliver the commitments they have made to customers in their business plans;
3. promote efficiency – including evidence that companies are choosing the most cost-beneficial performance levels to target for each outcome area and applying reasonable costs to do so;
4. ‘stretch’ their performance – including evidence that any rewards are being earned by innovation or performance beyond the planned and expected levels. Performance levels underpinning all incentives should be consistent with companies striving to improve their absolute performance and performance relative to their peers to the levels that represent the best value for money for their customers;
5. are fair – including evidence of balance in the upside/downside risk and that incentives cannot be ‘double counted’ with other incentive mechanisms such as the total expenditure (‘totex’) efficiency incentive;
6. are likely to apply in practice – wide deadbands or neutral zones where no financial consequences are associated with changes in performance can mean that the practical impact of financial incentives is greatly reduced. A sufficient breadth of financial incentives proposed is also important to ensure that key aspects of performance are covered to at least some extent, and actual delivery does not become unduly biased towards areas where financial rewards are greatest; and
7. are transparent – including evidence that performance can be assured independently and that companies will use it to explain their performance achievements (or shortfalls) in their continuing discussions and engagement with customers.

Ofwat has drawn particular attention to the need for the water companies stretch their performance, where it wants to see the firms include more stretching incentives and provide more complete, and higher-quality, evidence. The regulator said that in many business plans, companies had not supported the explanation of incentives with evidence that allowed it  to confirm whether the proposals follow the PR14 price control methodology, or if a departure from it could be justified.

The regulator pointed out that it would still intervene to amend companies’ business plan proposals to safeguard customers if the supporting evidence was not provided to demonstrate that the incentive is effective.