Cost of Service and Rate Design

​Cost of Service Study

Once the appropriate level of revenues for the test year is determined, the next task is to provide a fair allocation of these dollars to ratepayers.  The typical means of accomplishing this allocation is to conduct a Cost of Service Study (COSS).  The principal reason for performing a COSS is the fact that the water system provides service to a number of different classes of customers who have different water use patterns and demands.  Therefore, different customer classes have different conditions of service; an equitable rate structure must recognize these differences. PSC staff uses AWWA's “Base-Extra Capacity" methodology to allocate costs.  This method is described in detail in AWWA's M1 Principles of Water Rates, Fees, and Charges Manual

To view the Table of Contents from the most recent release of the M1 Manual, as well as read an overview of cost-based water utility rate-making, visit the AWWA website: M1 Manual: Look Inside

How are customer classes defined?

The PSC recognizes five primary customer classes for water service, including:

  • Residential customers includes single-family homes, duplexes, and individually-metered condominiums, apartment buildings, and mobile home parks.
  • Multifamily Residential customers includes master-metered multifamily dwelling units such as condominiums, apartment buildings, and mobile home parks.
  • Commercial customers includes business entities and institutions, except governmental entities, that provide goods or services. Churches and parochial schools are not governmental and are classified as commercial.
  • Industrial customers includes customers who are engaged in the manufacture or production of goods.
  • Public Authority customers includes any department, agency, or entity of local, state, or federal government, including public schools, colleges, and universities.

In addition, some utilities have chosen to establish a separate class for irrigation-only customers, which typically includes customers who have a separate meter for outdoor water use. This class is defined as follows:

  • Irrigation customers includes customers who have water service provided primarily for landscape irrigation. For the purpose of this schedule, landscape irrigation includes the use of water to sustain crops, lawns, or landscapes on any residential, multifamily residential, commercial, industrial, or public authority property, including water used for irrigating athletic fields, parks, and golf courses. Irrigation customers include those customers that have multiple meters installed on a single lateral for the purpose of measuring water that is not discharged to the sanitary sewer system. The utility shall classify each additional meter as an irrigation meter and treat each meter as a separate general service customer.​

​​​Rate Design

The final rate design step is developing rates that allow a utility to meet its revenue requirement and provide a fair distribution of the costs between customers based on the cost of providing service.  There are several important criteria to keep in mind when designing rates.  Rate development involves addressing multiple objectives and should result in a rate design that is practical, easily understood, has a clear, single interpretation, is based on the cost of providing service and meets the appropriate revenue requirement based on those costs, provides relatively stable revenues, avoids unnecessary rate shock, is not unduly discriminatory, and discourages wasteful use. Rate design issues are covered in depth in AWWA's M1 Principles of Water Rates, Fees, and Charges Manual.