Water industry regulator Ofwat has published some of the background data it has used in its draft determinations for the 2014 price review to analyse the water companies’ outcome delivery incentives(ODIs).
As part of its work on draft determinations Ofwat carried out comparisons – described as ‘horizontal checks’ - between the water companies’ performance commitments and outcome delivery incentives. The regulator compared across the five areas where there was most coverage in companies’ outcome packages and where the data were most comparable. The five areas are:
- drinking water quality (mean zonal compliance)
- negative water quality contacts
- water supply interruptions
- properties affected by internal sewer flooding
- pollution incidents (Environment Agency category 3)
The analysis is presented in a series of detailed excel spreadsheets – Ofwat points out that they are working documents and were not designed with publication in mind. The regulator said it is publishing them now so that all stakeholders can see the methods used.
Ofwat has also pointed out the identification of a small error in the calculation of the upper quartile performance level for water supply interruptions. The regulator used 1.22 contacts per 1,000 of population in the draft determinations for water companies, but the working spreadsheet uses the correct value of 1.23 contacts per 1,000 of population.
The data is an interesting indication of the level of detailed analysis the regulator has had to undertake in order to reach its draft determination decisions. It is also a useful indicator of the key areas where the data provided by the water companies were most comparable. In a paper accompanying the Draft Determinations in August the regulator said it had “only been able to undertake comprehensive horizontal checks on a few measures of performance at sector level.” Ofwat referred to six areas identified by the horizontal checks, including leakage, which has not been included in the data published today.
The areas analysed are related to asset health - a number of the companies had proposed ODIs on asset health metrics to provide stakeholders with long-term insights and predictive capability. Interestingly, asset health was not an area stipulated by Ofwat itself in its methodology as requiring a standardised incentive framework. Ofwat’s focus in PR14 is on totex, which will allow companies greater flexibility to rebalance operating costs and capital expenditure.
However, asset health is seen as a key consideration for the regulator given the potential customer detriment that could arise if company decisions result in deterioration of water company assets.
Ofwat’s review of the business plans showed that the companies put forward 399 outcomes in total with associated performance commitments. Of these, the companies have proposed financial incentives which apply to 59% of their commitments.
Commenting in August on the use of outcome delivery incentives, Ofwat said that in addition to the near term benefits to customers of improved outcomes, the approach it has adopted will reveal valuable information on companies’ ability to deliver various outcomes. This would in turn allow even greater benefits to customers in subsequent price control periods, with the information used to sharpen and target the incentives.
Following guidance from Ofwat, the water companies themselves reduced the number of non-financial incentives from 68% in the December 2013 Business Plans to 41% in the June 2014 revised plans.
Breakdown of incentives by type – December and June business plans across all companies
|
Incentive by type |
December Business Plans |
June Business Plans |
|
Non-financial incentive |
68% |
41% |
|
Penalty only |
21% |
24% |
|
Penalty and reward |
11% |
35% |
(Source:Ofwat)
The regulator said it had undertaken detailed comparisons of similar proposals put forward by different companies where it was possible to do so, commenting:
“These horizontal checks are an important safeguard of customers’ interests. They help us to maximise the value of comparative competition by benchmarking outcome incentives and costs.”
Ofwat’s final methodology statement allowed the companies considerable freedom to develop outcomes that reflected the needs of their customers. Leakage and the service incentive mechanism (SIM) were the only areas in which all companies were required to include an incentive. It will be interesting to see whether a broader analysis of more areas with comparable data on companies’ outcome packages becomes available in subsequent Price Reviews.
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