Conclusion of Excerpts from the Report of the Committee on This Subject of the American Water Works Association—Final Suggestions -Some Rules to Be Considered in Establishing Rates

(Continued from page 1123)

The principles which apply to establishing fair rates may be stated as follows:

  1. Fair and equitable rates must cover all of the operations of the water utility.
  2. The division of the rates among the consumers must be such as to give no undue preference to one class of consumer over another.
  3. In determining how the rates should be divided, the cost of the service required by each class of consumer must be determined, and the entire cost, so far as possible, divided among the different consumers who take different classes of service.

Bearing these facts in mind, your Committee will attempt to outline but one method of allocating charges, for by so doing much confusion will be avoided. The method chosen complies substantially with the system of rates which has been adopted by the Public Utility Commissions of New Jersey, Pennsylvania, Maryland, Wisconsin, and possibly other commissions.

The problem of establishing fair rates may be broadly stated as follows: Every water works plant, municipal or private, has a certain sum of money invested upon which it must pay interest or dividends, or both. In addition, it must set aside an annual reserve for depreciation, or pay annually into a sinking fund an amount sufficient to retire its outstanding bonds at maturity. It must also pay operating and maintenance expenses and taxes. If the property is exempt from taxation, they need not be included in the gross revenue required, but the principle is the same. If the plant is self-supporting, these expenses must be paid for from the revenues of the water works, whether municipal or private. The revenues must be derived from the rates if justice is to be done to all.

The problem of devising a schedule of rates which distributes the cost equitably among all classes of consumers involves two main operations, therefore:

A. Determining the gross revenue required to provide interest or dividends, or both, plus a proper allowance_ for operating expenses, taxes, and a reasonable annual reserve for depreciation or sinking fund charges as the case may be.

B. Establishing the incidence of the rates by:

1. A fair separation of the area served by the water purveyor into districts if, under the conditions of service existing in the plant, certain consumers possess the advantage of location, whereby the cost of delivering water to some is less than the cost of delivering water to others. Such a separation of area is not necessary if an average rate for the entire area may be used.

2. Subdividing the gross revenue between:

a. Miscellaneous revenue.

b. Public fire service revenue.

c. Revenue derived from the sale of water to domestic, commercial,

manufacturing and public consumers.

3. Subdividing the revenue derived from the sale of water between proportional service costs and fixed service costs.

4. Subdividing proportional service charges for water supplied between the classes of consumers as a means of establishing a sfiding scale of rates, if desired, which varies with the cost of supplying water in different quantities.

Proportional costs are kinetic costs, which vary closely with the amount of the production or output or the amount of water consumed, and, therefore, include the production or output costs. The cost of pumping and filtering is in large measure a production cost, and all operating and maintenance expenses on the used capacity of the distribution system should be charged to proportional cost.

Fixed service costs arc the static costs which do not vary with the quantity of water produced. Fixed service costs are composed of two elements:

1. The demand, capacity or readiness to serve cost.

2. The service or customer cost.

The capacity or demand costs do not vary with the output, but with the capacity which a plant must have to meet the demand without regard to the amount of water consumed. In every plant sufficient capacity to meet the maximum demand which the water utility has contracted to supply when called upon to do so must he provided in addition to the capacity necessary to meet the ordinary and usual daily demand. The plant necessary to meet the spasmodic or unusual demand lies idle for a large portion of the time. The capacity chargeable to the capacity or demand cost is the surplus capacity of the system not apportioned to fire service, which represents the capacity required to meet unusual or spasmodic demands or to provide reasonable future development. The capacity or demand cost is, therefore, chargeable to plant made necessary to meet the contractual obligations of the water utility to furnish this demand, and is in substance a readiness to serve charge. The courts and public utility commissions have recognized the propriety of a readiness to serve charge.

In addition to the capacity or demand costs, service or customer costs must be provided for. These costs result directly from individual service rendered to the customer. They include interest and depreciation, or sinking fund charges, on the cost of the service connection and meters, if the cost of installation is paid for by the water purveyor. They include the cost of reading meters, of rendering and collecting bills, of repairs to service connections, meters and appurtenances, and in the case of private fire protection service, special inspection expenses. Such costs would not accrue if the plant existed in its entirety without consumers.

The total fixed service charge is the sum of the service or customer cost, and the capacity or demand cost. Both of these costs vary generally with the size of the service connection or meter. While this is not a precisely accurate statement, it is, broadly speaking, true, and it must be remembered that what is wanted in a system of rates is not mathematical precision but simplicity, and it is necessary to make some approximations in order to arrive at a simple rate schedule.

A correct analysis of service costs clearly indicates that the separation of fixed service costs and proportional service costs is not a subtle distinction, but a rational separation based on the fundamental principle of assessing the fair cost of the service to each consumer. One consumer may desire a connection of large capacity through which a small amount of water is ordinarily taken, but which may be utilized to full capacity at infrequent intervals, whereas another may consume water in quantities reasonably proportional to the size of his service continuously throughout the year. Why should the latter pay for the utility’s readiness to serve the former? The readiness to serve bears a direct relation to the size of the plant and, therefore, to the fixed investment in the property necessary to give service on demand.

The gross revenue, which it is necessary to derive in order to secure interest plus a proper allowance for operating expenses and taxes and a reasonable annual reserve for depreciation or sinking fund charges, is derived from two main sources:

1. Revenue derived directly from water service, or the sale of water, which includes the revenue derived from public fire protection, as well as that derived from domestic, industrial, commercial and manufacturing, or public uses other than fire, and

2. Miscellaneous receipts which include revenue from turn-off and turn-on charges, meter change charges, meter repair charges, plumbers’ fees and fines, and non-operating revenues derived from rent, interest on deposits, and other miscellaneous sources.

The principal steps in the establishment of a system of rates may be outlined as follows:

The limits between which the charges for the different classes of service vary when properly allocated are too great to admit of suggesting a definite percentage chargeable to each, but the limits between which such charges vary, expressed as a percentage. have been given as a guide to the general problem of fixing rates.

The subdivision of charges between districts has not been attempted, for if the gross water service revenue which should be derived is properly subdivided between districts, the problem of allocating charges between different classes of service within a district is identical with the outline here given for the plant as a whole.

It is not the purpose of this report to go into the details of the method of making a fair apportionment of the revenues between public fire service protection and general water service. It is only necessary to say that the apportionment of costs to public fire service varies greatly with the size of the plant, the cost of public fire protection service being relatively much greater in small plants than in large plants.

Having ascertained the proper amounts to be collected from public fire protection and from general water service, the next step is to deduct the revenue derived from public fire protection from the total water service revenue, and apportion the remainder, or the general water service revenue, between revenue to be derived from fixed service charges, and from proportional service charges. The ratio of fixed service charges to proportional charges varies somewhat in different plants, but, in general, the fixed service charges fall between 20 and 40 per cent, of the revenue to be derived from general water service, which, of course, means that the proportional service charges vary between 60 and 80 per cent, of the same amount.

The theory on which operating expenses and fixed charges are divided between proportional and fixed service charges is that the direct expense of materials and supplies, as well as interest and depreciation or sinking fund payments on that portion of the plant which is utilized in producing and delivering the commodity supplied, should be included in the proportional charges. The proportional charge covers the cost of producing and delivering water for normal service requirements, and includes collecting and storing, pumping, filtering, transporting and distributing. In this way, coal and wages at a pumping station, chemicals and wages at a filter plant, and that proportion of the maintenance and care of the pumping station and filter plant, the distributing reservoirs, distribution system, and storage reservoirs, which is chargeable to actual output goes to the proportional charge for water.

Since the proportional charge varies with the quantity of water taken, the basis of charge should be so much per hundred cubic feet, per thousand cubic feet, or per thousand gallons.

The capacity costs are the costs chargeable to the excess plant made necessary to meet the contractual obligations of the company to furnish the maximum demand which the water consumer may make. Thus, the fixed charges on the reserve portion of the pumping stations, filter plants, impounding reservoirs, mains, etc., are chargeable to capacity cost. The material, labor and interest appurtenant to the reserve capacity should be charged to the capacity or demand cost.

The total fixed service charge for domestic, commercial, industrial and public uses other than fire, which is the sum of the capacity and consumer cost, should be levied as a fixed annual amount to be paid quarterly whether water is taken or not.

The fixed service charge may be based upon a capacity unit. The capacity unit has in a number of cases been fixed as the capacity of a 1/2-inch service connection or 1/2-inch meter. By ascertaining the capacity ration between a 1/2-inch service connection or meter, and the other sizes of service connections or meters, the number of capacity units in each size of service connection or meter may he ascertained. If all of the service connections or meters in a plant and their sizes are listed, the total number of capacity units in the system may be ascertained, and the net unit fixed service charge will be the quotient of the total revenue which should be derived from the fixed service charge divided bv the total number of capacity units in the water works system. By multiplying this capacity unit charge by the ratios established for the different sizes of service connections or meters, the fixed service charge for each size of connection or meter may be ascertained.

If it is desired to assess more than the cost of public fire service upon the taxpayer, the fixed service charge may be subdivided by assessing that portion of the charge due to excess capacity directly upon the property benefited, on any basis desired, and the remainder may be levied upon the water taker on the capacity unit basis above outlined.

Modifications in this respect may be made in individual cases to suit individual preferences, but the principle is the same. Attention should be called, however, to the advantage of establishing a uniform svstem of water rates, and of following practices which commissions regard as according substantial justice to all.

By deducting the revenue from the fixed service charges from the total revenue to be derived from general water service, the

amount to be derived from proportional charges for water used may be ascertained. When this is done, ascertain the total net pumpage, that is, the total pumpage less water unaccounted for due to pump slippage, leakage in mains, etc., and divide the total revenue to be derived from proportional changes by the total net water delivered to ascertain the rate per unit of water sold.

With such a system of rates established, it is simple to see that one who requires a large service connection and little or no water will pay only the fixed service charge, whereas one who requires a small service connection and a steady supply of water will pay for the bulk of his service through proportional charges. As one of the members of the Maryland Public Service Commission said, you buy water on the European plan. One pays so much for his room, and pays in addition for whatever he takes to drink. It is also simple to see that the charge which will be made for fire protection service under such a system of rates will be the fixed service charge, which will be the same as would be charged for any other connection of the same size without distinction or discrimination on account of the purpose for which the connection is desired.

The following rules should be considered in conjunction with the establishment of a system of rates of this kind.

When the word “consumer” is used, it is used to designate the party contracting: for or using: service on a premise.

When the word “premise” is used, it shall be taken to designate:

a. A building: under one roof owned or leased by one party and occupied as a residence, or for business or commercial purposes, or

b. A grroup or combination of buildings owned or leased by one party, occupied by one family, or one corporation or firm, or as a place of business, or for manufacturing or industrial purposes, or as a hospital or other public institution, or

c. One side of a double house having a solid vertical partition wall, or

d. A building owned or le&sed by one party containing more than one apartment and having one entrance and using one hall in common, or

e. A building owned or leased by one party having a number of apartments, offices or lofts which are rented to tenants, or

f. A public building such as a town hall, school house, fire engine house, etc., or

g. A single lot or park or playground, or

h. Each house iti a row of houses.

When the term “service connection” is used it is intended to mean the pipe line from the water main to a premise.

Where more than one service connection is used for one premise, or for one consumer, the fixed service charge shall be applied to each and every connection supplying one premise or one consumer.

Where two or more service connections supply the same premise or the same consumer, the consumer shall be billed at the schedule of proportional rates for a quantity of water equivalent to the sum of the readings of all meters on the premises.

Private fire hydrants shall be charged for at the same rates as public fire hydrants.

Respectfully submitted,

NICHOLAS S. HILL, Jr., Chairman







Excerpts from the Final Report of the Committee on Private Fire Protection Service of the American Water Works Association—Question of the Proper Charge— How It Should Be Determined

(Continued from page 979)

7. Shall Charge Be Made for Private Protection Service?

The questions involved in determining a proper charge for public fire protection have been little understood up to a very recent date, and proper charges for private fire protection still less so. Of late, however, the public utility commissions of various states have been called upon to distribute the charges for water service equitably. This condition of affairs has brought about an intensive study of the problem, with the result that much light has been thrown upon the situation. So far as the equitable distribution of charges is concerned, the decisions tend more and more to the establishment of the rule that free public lire protection is unfair to private consumers for the reason that the water taker is obliged to pay for privileges enjoyed by property owners, whereas the property owner should pay for this protection in proportion to the taxable value of his property.

The decisions further indicate a growing tendency to allocate a larger proportion of the total cost of supplying water to public fire protection and thereby to make the taxpayer assume a larger share of the burden of expense for water supply purposes.

Now, who should bear the normal cost of furnishing private fire protection service? Admittedly, it must either be the one who takes this service, the other customers of the water utility who do not take this service, or the taxpayers of the community. It is also pertinent to ask in this connection who benefits by private lire protection service—the water taker or the taxpayer?

It has been argued that the use of private sprinkler systems reduces the amount of water which otherwise would be used through the municipal fire apparatus. It has also been urged that private fire protection systems are a benefit to the community and ought to he encouraged by it. The insurance interests claim that the private hydrants and sprinkler systems are merely devices by which owners are able to apply water on their premises more efficiently and economically than through the usual public means, and they are thus supplementing and improving the w’ork of the fire department: that ordinarily fire is extinguished with less use of water through private fire protection, and that the private fire protection system adds no burden upon the water works. The privately protected plant merely asks to he allowed to buy those tools which experience has shown make the use of public water possible with greatly increased effectiveness. For these various reasons, it is argued that no charge, or a nominal charge, should be made for this service.

The argument that private fire protection service should be furnished free or at a nominal cost is fallacious. Private fire protection for individuals should not be secured through a rebate in the water rates, and at the expense of other water takers, but by recourse to legislation making all property owners live up to rules and regulations which are compatible with the requirements of public safety. As the Public Utilities Commission of the State of Maine has nut it in an opinion rendered in the Portland Water District Case:

The proprietor of a manufacturing plant, or building filled with inflammable materials, or a place otherwise more than ordinarily exposed to dangers from fire within, has no more moral right to impose upon the community the added dangers incident to his particular business without taking recognized precautions to minimize the danger than to commit any nuisance forbidden by law. He has no more moral right to establish an excelsior factory in a city without taking inside fire precautions commensurate with the peculiar hazard attendant upon that business than he has to ignore the recognized precautions against the spread of a contagious disease. The owner of a fireproof structure in a wooden built section of the city would not expect relief from any part of the general tax burden because he had reduced the tire hazard. He would expect the owners of other buildings to comply with reasonable fire prevention rules at their own expense.

The remedy for the lire hazard should not be looked for through free lire protection service, but through a proper reconstruction of the building codes and fire laws.

Even if it were admitted that private fire protection service should be given free, the cost of this service should not be distributed among other water takers, but upon the taxpayers. If the community, as such, and not as water purveyor, wishes to assume the burden of this class of service, that is another matter, but the burden ought to be distributed by direct taxation in the same manner as a community does when offering tax-free land to induce manufacturing plants to locate within its confines. If the burden is borne by the users of other classes of water service, it is distributed according to the amount of service taken for other purposes, and has no relation to the direct benefit conferred.

The reduction of the conflagration hazard and insurance rates on surrounding property is a property benefit, and is not measured by the amount of water service taken by other water consumers. If the installation of sprinklers is to be rewarded by an exemption from tolls because it is a benefit to other property, the property benefitted ought to be made to assume the shifted burden. Its refusal or neglect to do so does not justify putting it on those consumers who neither own sprinklers nor benefit by their installation.

In weighing these arguments, it should be remembered that in 30 per cent, of the fires in sprinklered risks, the fire department is called into play, and also that the installation of private fire protection systems, where they do not extinguish incipient fires, may add a heavy drain upon the public piping system and thereby jeopardize the public fire protection. The danger of a large waste of water inside a protected property in the event of a destructive fire, due to connections to it, is very great. It is difficult to locate valves where these connections may always be shut off when they have ceased to do good, and they commence to do incalculable harm. Usually what is wanted in a fire protection system is a reasonable amount of water at an effective pressure. Sometimes what is demanded is an unreasonable amount, which means that not alone the sprinklered risk, but the surrounding property is endangered, and the water withdrawn is used to no good purpose.

No one who realizes the manifold problems which private fire protection service develops can for an instant doubt that the water purveyor assumes not alone responsibility and cost, but possibility in rendering such service. The furnishing of private fire protection by a water utility is one of its legitimate activities, and constitutes an important part of the service it is intended to render. This service can no more be rendered without the existence of a completed plant than any other service can. The plant investment, upkeep and operation is as essential to this as to any other. There is no reason for making a distinction between this and other classes of service rendered by the utility. None should be exempt from carrying its fair proportion of the whole burden. There is no more reason for exempting the takers of private fire protection from meeting their proper share of the total cost of service than for exempting other patrons of a water utility.

Two things must be considered in establishing a fair basis for a charge for service: first, the cost of the service, and then the worth of the service to the consumer. The consumer is entitled as a matter of right to adequate service at reasonable rates under reasonable conditions, and to pay no more than the worth of the service.

It has been demonstrated that private fire protection service entails cost. The one question remains, then: Has this service worth to the one who takes it? In answer to this uuestion. we will quote from the testimony of the insurance experts in the Portland Water District Case previously referred to. From this testimony we find that the introduction of a private sprinkler system resulted in one case in a re duction from $2.04 per $100 of insurance to 34 cents, on one section of a plant, and to 40 cents on another. The Portland Stove Foundry carried in excess of $100,000 of insurance as an unsprinklered risk. Its rate was $1.70 per $100. As a sprinklered risk it was 22 cents per $100, a saving in insurance of $1,480 per year, which capitalized at S per cent, is equivalent to $29,600. The installation and maintenance of private fire protection systems entil cost, so that the difference as shown above is not all net saving, but in the majority of cases the reduced rates pay for the fire protection installation in from five to eight years. The saving effected by the installation of these systems is very much larger than the cost, and it should be borne in mind that these figures take no account of the saving effected by insurance against interruptions to business not compensated for by the kind of insurance herein discussed.

With relation to decisions affecting private fire service protection, there is an apparent unanimity of opinion by courts and public utility commissions, to the effect that a water utility which supplies water for private fire protection purposes performs a service which is in addition to supplying water for public fire protection, and the water utility has a right to make a reasonable charge for private fire protection service.

The service required of a water utility is of two classes:

  1. Readiness to serve a large quantity of water at irregular and indeterminate intervals whenever called upon.
  2. A constant supply of water with comparatively slight variation in the amounts called for.

The private fire protection consumer falls into the first class. What he requires is a connection of large capacity through which a small amount of water is ordinarily taken, but which may be utilized to full capacity at infrequent intervals. His needs are distinct from those of the ordinary domestic consumer, who requires a quantity of water continuously and substantially proportional to the capacity of his service connections. In the case of one, we have capacity cost; in tlie other, production cost. Since the cost of service should not be shifted from one source to another in the rates, it follows that the consumer who requires the utility to incur capacity costs should not put the burden of paying for them upon the consumer who does not want capacity, but wants water. Under the circumstances, therefore, your Committee has no choice but to recommend that a charge for private fire service connections be made.

8. How Should the Charge for Private Fire Protection Be Determined?

In attempting to outline the method of establishing a system of rates, it may be well to remark at the outset that the existence of a mixed schedule for mete_____d and unmetered water greatly complicates the problem of distributing the cost of water between consumers. There i no basis for establishing a rational system of flat rates. Sum a scale of rates is at best a makeshift, and one man’s guess is as good as another’s. A system of flat rates is based upon estimates. Such estimates are formulated on widely different plans, such as the number of fixtures, rooms or persons in the house, the floor space, or the height of the house, the number of feet front which it occupies, or the purpose for which water is used. Such schedules are of necessity incorrect and work unevenly, requiring consumers under certain conditions to pay but little, and under other conditions to pay exorbitantly for the water they use. The water works system that attempts to work on a flat rate schedule cannot possibly do even approximate justice between its consumers. Under these circumstances, your Committee has not attempted to suggest a method of ascertaining a proper charge for private fire protection service where flat rates are in vogue.

The fact that it would be impossible for this Committee to establish a rate for private fire protection service is too apparent to need mention. Rates vary with the cost of service. The cost of service varies with local conditions and, therefore, the rate for one situation would not necessarily be the rate for another. All that can be done is to outline a method by which it will be possible to establish an equitable rate for private fire protection service. In doing this, your Committee fully recognizes that there are differences of opinion with regard to the allocation of costs to produce equitable rates. There are certain general principles, however, upon which courts, commissions, and water purveyors seem to be agreed, among which may be mentioned:

  1. The cost of service should he equalized between the water taker and the taxpayer and heretofore the water taker has frequently been assessed more than his just share of the cost of water service, due largely to the fact that an insufficient amount of revenue has been derived from public fire protection service.
  2. Public fire protection service is a property benefit and the cost of this service should be assessed upon the property owner or taxpayer, and not upon the water taker.

With much reason, some advocate going a step further by assessing all costs attributable to excess plant, whether installed for fire protection, or to meet future development or extraordinary demands, upon the taxpayer. That is, to assess the taxpayer for the interest, depreciation and maintenance of all plant required beyond that to meet the ordinary maximum daily consumption for domestic, industrial and manufacturing uses. The theory of allocation is the same in principle, whether the excess due to fire protection alone or both are included in the general tax levy. The difference is one of degree to which the taxpayer is assessed for his proportion of the cost of supplying water. In practice, it will be found that if the costs attributable to the plant necessary for public fire protection, or to that portion of the plant which it would not be necessary to install in the absence of public fire protection service, are levied upon property and not upon the water taker, the theory of assessing all surplus capacity upon the property owner will be substantially complied with.

(Continued on page 1135)

Fig. 12.—Diagrammatic Subdivision of Revenues and Charges

A. W. W. A. Private Fire Protection Service

(Continued from page 1123)

  1. It is generally conceded that the revenue to be derived from general water service, that is. the revenue derived from domestic, commercial, manufacturing and public consumption for other than fire protection purposes, should be subdivided between fixed service charges and proportional service charges.
  2. There should be no free water, not even for municipal or public purposes other than fire protection.

(To be continued)