The Director welcomes views on the issues raised for consultation in this paper.

Please send them to:

Charles Whitworth
Head of Tariffs
Office of Water Services
Centre City Tower
7 Hill Street
Birmingham
B5 4UA

Or by fax to: 0121 625 1379

by 5pm on Friday 13 August 1999.

If you wish to clarify any points about the scope of the consultation, please contact Julia Havard, Head of External Relations on 0121 625 1450, in the first instance and she will ensure that your query is dealt with.

All responses should be marked "Approval of Charges Schemes consultation". Unless otherwise requested, responses will be placed in the Ofwat Library and made available to the public.

CONTENTS

Foreword

Summary

1.The purpose of the consultation

1.1 Purpose of the consultation

1.2 Power to approve charges schemes

1.3 Coverage of charges schemes

2.1 Charging policy objectives

2.2 Legal obligations

2.3 Guidance to the Director from the Secretary of State and the Welsh Assembly

3.1 Regulated charges

3.2 Timing and methods of payment

3.3 Metering

4.1 Proposed timetable

4.2 Critical dates

4.3 Approval procedure

A. The current legal framework

B. Policies for cost-reflective charging

C. Charges schemes - current best practice

D. Glossary

E. List of consultees

FOREWORD

When the Water Industry Bill, which is currently before Parliament, passes into law, I shall have a new power to approve companies' charges schemes.  In the 1999-2000 Report on tariff structure and charges I have already consulted on the process that should be followed for the approval of charges schemes coming into force on 1 April 2000.  I am now consulting on the criteria which I should use in approving charges schemes for 2000-2001 and beyond.

In this paper I have set out what I believe to be the minimum content of a company's charges scheme and the policies that companies should apply in each area.  The approach that I will adopt will be essentially an evolutionary one. It will build on the policies that I have sought to apply on charging policies, on metering, and on customer service issues since 1989.

The Bill would give power to Ministers to prescribe methods of charging for vulnerable groups.  Their precise intentions will be set out in Regulations later this year.  These will give effect to the Government's policy that where it wishes to implement social or environmental measures which would have significant financial implications for consumers and for the regulated companies, these measures should be implemented through new, specific legal provision.

When the Bill passes into law, the Secretary of State and the Welsh Assembly will also issue guidance as to matters they wish me to take into account when I approve companies' charges schemes.  Ministers have told Parliament this will be on social and environmental objectives.

The Water Industry Bill also provides me with the opportunity to consult, which this paper begins.  It is primarily designed to enable me to understand the views of customers.  I am asking the Customer Service Committees to reply on behalf of customers by 13 August 1999.   I would also welcome other views from customers, and, of course, from water companies.

When this consultation is completed, I will write a public letter to the water companies in early September 1999.

I C R Byatt
Director General of Water Services

SUMMARY
Legal framework

Each company is currently under a duty to avoid undue discrimination or undue preference in charging its customers.  The Director General of Water Services (the Director) has a duty to secure compliance with that obligation.   At the same time, he is required to protect the interests of customers and potential customers, including those in rural areas.  These duties will continue to be an important feature of the Director's role in approving charges schemes.

In addition, the Water Industry Bill (the Bill) proposes that the Director should, in approving charges schemes, ensure that they comply with Regulations issued by the Secretary of State for the Environment, Transport and the Regions (the Secretary of State) or the Welsh Assembly.  Apart from Regulations, it would also require him to have regard to whatever guidance they may give to him on the exercise of this new power.

The Competition Act 1998 will take effect on 1 March 2000.   In deciding whether to approve charges schemes, the Director will examine their contents, to see whether they raise any issues of non-compliance with either of the Act's prohibitions of anti-competitive agreements or conduct, or of the abuse of a dominant position.  The Director thinks it sensible that these issues should be raised and dealt with as part of the process leading to approval of charges schemes, rather than leaving them to be re-opened after charges have been applied. 

Purpose of the consultation

The purpose of this paper is to consult on how the Director  proposes to implement his newly acquired statutory powers - under the Water Industry Bill  - to approve companies' charges schemes and to oversee companies' policies relating to the installation of optional meters.

This power to approve will come into force starting with charges schemes for the year 2000-2001. Thereafter, the Director will approve charges schemes on an annual basis. The approach will be evolutionary, building on the Director's policies on charging issues, on metering and customer service issues.

Companies' charges schemes in 2000-2001 should cover: all regulated charges, timing and methods of payment and companies' metering policies (including provision for the optional meter entitlement).

Director's objectives

The Director's key objectives, originally set out in Paying for water: A time for decisions 1991, remain valid.   They are:

• Fairness and equity, to ensure that customers in similar circumstances pay similar charges; and that, where they face different bills, the differences in charges properly reflect relevant differences in circumstances.
• Incentives to customers and companies, to help ensure that the right level of service is provided at the right price, and efficiency in the use of water is promoted.
• Simplicity and comprehensibility, so that customers are clear about how their overall bill is made up and what they can do to influence it.

Water Industry Bill - Regulations and the Secretary of State's Guidance

The Secretary of State has said he would be providing in Regulations the charging arrangements to be used to protect vulnerable customers. He would also be providing in Regulations to allow companies to continue to meter household customers where they are using certain types of water appliance, and in other prescribed circumstances. The Welsh Assembly may also issue Regulations for customers of Dwr Cymru (Welsh Water) and Dee Valley Water.

When the Bill passes into law, the Secretary of State will issue guidance to the Director with respect to his power to approve charges schemes. For customers of Dwr Cymru and Dee Valley Water, the Welsh Assembly may also issue guidance. Ministers have told Parliament this will be on social and environmental  objectives.

In approving charges schemes the Director would ensure that they also comply with all relevant legal obligations as set out in Regulations.   He would also have regard to any guidance issued by the Secretary of State and the Welsh Assembly.

Regulated charges

Subject to this consultation, the areas in which the companies will be expected to apply cost-reflective charging principles will be in relation to:

• the balance between water and sewerage charges;
• the balance between measured and unmeasured charges;
• the balance in charges between those related to use and those reflecting customer-related costs;
• sewerage, surface drainage, highway drainage and trade effluent charges;
• large user tariffs and the design of tariffs for discretionary use of water.

• Q1. What is the scope  for and desirability of, departing from cost-reflective charging principles for regulated charges?
• Q2. How should companies design their tariffs so as to ensure they remain broadly cost reflective and preserve incentives to efficiency when they implement any price reduction for 2000-2001 (the Po adjustment)?
  
  Timing and methods of payment

For optional metering, the Director considers that the preferred balance lies in a package of measures which reflects the principle of an entitlement to a free meter but seeks to manage the pace of change. The Director has set out his proposals on how he expects companies to achieve this objective in respect of; reasonable expenses, choice of location, time-scales for installation, payment conditions, assessed charges, and information to customers. Policies in each of these areas should be included in company charges schemes. 

• Q4.  What are your views on the balance to be struck between facilitating optional metering and managing the pace of change?  Do you agree with the Director's proposals on the way in which companies should provide customers with their entitlement to a meter free of installation charge?

Proposed approval procedure

The Director is at present consulting in the 1999-2000 Report on tariff structure and charges on the timetable for approving charges schemes. This paper also sets out the critical dates and key stages within the proposed approval procedure.

THE PURPOSE OF THE CONSULTATION

1.1 Purpose of the consultation

The purpose of this consultation paper is to consult on how the Director proposes to implement the statutory power he would be given under Clause 4 of the Water Industry Bill (the Bill) to approve Appointee's charges schemes.

The timetable for the approval process for 2000-2001 is the subject of a separate consultation in the 1999-2000 Report on tariff structure and charges.

The Director believes that the approach to approving company charges schemes set out in this consultation should be essentially an evolutionary one. The suggested approach builds on the Director's policies on charging as developed since 1989 as set out in Paying for water 1991 and in Ofwat's annual reports on tariff structure and charges.

Each company is currently under a duty under the Licence to avoid undue discrimination or undue preference in charging its customers.  The Director has a duty to secure compliance with that obligation.  At the same time, he is required to protect the interests of customers and potential customers, including those in rural areas.

To date the Director has sought to influence company charging policies through the application of his duty as it relates to charging in terms of the avoidance of undue discrimination and undue preference.  Appendix  A explains the legal framework as it relates to companies' charges schemes and the Director's duties on charging.  It also summarises the main provisions of the Bill.

1.2 Power to approve charges schemes

Clause 4 of the Bill, when enacted, will give the Director the power to approve charges schemes. This power to approve would come into force starting with charges schemes for the year 2000-2001.  Thereafter, the Director would approve charges schemes on an annual basis.

In approving companies' charges schemes, the Director would require that they:

• comply with Regulations made under the Bill by the Secretary of State or the Welsh Assembly; and
• comply with the objectives and approval criteria set out by the Director himself, who would have regard to the guidance provided to him by the Secretary of State or the Welsh Assembly.

Clause 3 of the Bill would remove companies' ability to charge household customers by agreement - they would have to be charged in accordance with an approved charges scheme.

Charges schemes are currently required to set out the following:

• the level of charges to be paid for providing any regulated service to customers;
• the times and methods of payments of the charges.

Companies would be required, under Clause 6 of the Bill, to set out the time-scales under which households will be able to take up optional meters as provided for in the Bill.

Companies' charges schemes in 2000-2001 would be expected to cover as a minimum the two items above and company metering policies (including provision for the optional meter entitlement).

2. THE DIRECTOR'S OBJECTIVES

2.1 Charging policy objectives

In Paying for water - a time for decisions 1991, the Director set out three key objectives in relation to charging for water and sewerage services which he believes still remain valid:

• Fairness and equity, to ensure that customers in similar circumstances pay similar charges; and that, where they face different bills, the differences in charges properly reflect relevant differences in circumstances.

This reflects the fact that under Condition E of the Licence companies are required to set charges without undue discrimination/undue preference.  The Director also has a specific statutory duty under the Water Industry Act 1991 to ensure that there is no undue discrimination or undue preference in a company's charges.

However, fairness - in the sense that charges should broadly reflect costs - need not imply that all cross-subsidy is inappropriate and in practice, regard must be had to other objectives, as well as to practical issues.

• Incentives to customers and companies, to help ensure that the right level of service is provided at the right price, and that efficiency in the use of water is promoted.

The Environment Act 1995 placed a statutory duty on companies to promote the efficient use of water by their customers. The Director ensures companies comply with this duty. To provide proper incentives, tariff levels and structures must be such that changes in bills broadly reflect changes in the costs of supply. Measured tariffs that signal appropriate incentives to customers are particularly important for household customers using water for discretionary purposes (such as garden watering) and for large users of water.

• Simplicity and comprehensibility, so that customers are clear about how their overall bill is made up and what they can do to influence it.

As metering becomes more widespread, sophisticated measured tariff structures will become more common. These alternative tariff structures may be targeted at specific types of demand but must also meet the objectives of cost-reflectiveness and appropriate incentives.

The Director considers that these objectives should continue to set the main criteria by which companies' charges schemes should be assessed.   Inevitably, however, a balance has to be struck between objectives; the Director will want to take account of the views expressed on the detailed proposals set out in this consultation as well as any guidance issued by the Secretary of State or the Welsh Assembly.

Also, when tariff structures are changed, the pace of change should not be such as to face individual customers with excessive increases in their bills from one year to another.  As a consequence, some customers may need to pay more in the meantime than would otherwise be the case.

2.2 Legal obligations

In the White Paper, A Fair Deal For Consumers, Ministers said that "where (Government) wishes to implement social or environmental measures which would have significant financial implications for consumers or for the regulated companies, these should be backed by new, specific legal provision".

The Secretary of State has said that he intends to provide protection for vulnerable households on measured charges - the cost of which should be met by water customers as a whole.

He has also said to Parliament that he will be providing Regulations under the Bill for the charging arrangements to be used to protect vulnerable groups on measured charges.  These will be issued as draft Regulations by autumn 1999, on which the Secretary of State will consult.

The Secretary of State has indicated that he will provide for the following two categories of vulnerable household in this way:

• those measured customers on low incomes with three or more children and in receipt of one of four types of qualifying benefits;
• those measured customers with one of four specified medical conditions requiring high water use.

In approving companies' charges schemes the Director would ensure that they comply with all legal obligations as set out in Regulations.

2.3 Guidance to the Director from the Secretary of State and the Welsh Assembly

In approving charges schemes, the Director would be required to have regard to any guidance received by him from the Secretary of State.   In the case of customers of Dwr Cymru and Dee Valley Water, this guidance would be provided by the Welsh Assembly.

The Secretary of State has indicated that he would issue draft guidance to the Director in summer 1999, on which he would be consulting. Ministers have told Parliament that statutory guidance to the regulator will be on social and environmental objectives.

3. APPLYING THE DIRECTOR'S APPROVAL POWERS

3.1 Regulated charges

In Chapter 2 the Director set out the charging policy objectives that he intends to apply to company charging policies. 

Subject to this consultation, the Director considers that these objectives are best achieved by continuing to apply the principles of broadly cost-reflective charging. The Director wishes to follow an evolutionary approach in developing these principles.  His policies for cost-reflective charging are set out in the 1999-2000 Report on tariff structure and charges and in previous years' Tariffs reports.  Subject to this consultation the areas in which the companies will be expected to apply cost-reflective charging principles will be in relation to:

• the balance between water and sewerage charges;
• the balance between measured and unmeasured charges;
• the balance in charges between those related to use and those reflecting customer-related costs;
• sewerage, surface drainage, highway drainage and trade effluent charges;
• large user tariffs and the design of tariffs for discretionary use of water.

The Director's proposals

Cost-reflective charging and vulnerable groups

Decisions about protection for particular groups are essentially matters for Ministers rather than the economic regulator, especially where any measure that reduces bills for one group of customers may need to be funded by higher bills for others.  This approach is in line with the Government's decision that, where social measures such as tariffs for vulnerable customers, may result in significant financial implications for customers or for regulated companies, provision should be made for this under new, specific legal provision.

In so far as the duty to apply broad cost-reflective principles allows scope for achieving social (and environmental) objectives, the Director wishes to consult on the scope, and desirability, of departures from these principles.

Q1. What is the scope for and desirability of, departing from cost-reflective charging principles for regulated charges?

Application of price reductions in April 2000 to companies' charges

The Director welcomes views on how the expected price reductions in 2000-2001 (the Po adjustment) should be applied by the companies to different customer groups.  He believes that applying cost-reflective charging principles will have implications for a number of different areas of charging.  His views on the application of such principles to each of the major areas of charging policy are summarised below:

• The balance between water and sewerage charges: the application of cost-reflective principles could mean that relatively water charges may need to rise and sewerage charges may need to fall in April 2000 in order to equalise rates of return on the two services.  The Director will be publishing an indicative slit of the Ks setting out the relative movements of charges for the two services when he publishes his draft determinations of price limits in July 1999.
• Structure of the measured tariff: in order to maintain proper incentives within the structure of the measured tariff the Director believes that companies should consider carefully whether they apply any reduction in charges in 2000-2001 evenly to both the standing charge and the volumetric rate. Volumetric rates should be set to encourage customers to use water efficiently.
• Surface water drainage charges: the Director considers that all companies should make better estimates of the separate costs of providing for foul sewerage, surface drainage and highway drainage services.  He also considers that companies should commit themselves from April 2000 to the provision of rebates for non-connection where a customer can demonstrate that the property concerned does not benefit from the service.  Some companies will already be in a position to apply such rebates from 2000-2001.  In this case there would be some rebalancing of bills between connected and non-connected customers for surface drainage. Such a provision, however, should  not be retrospective.
• Water for discretionary purposes: the Director believes that where company metering programmes are sufficiently advanced, appropriate tariffs should be in place. Measured customers using water for discretionary purposes (eg for garden watering, swimming pools etc) should not then see charges fall in April 2000 to the same extent as those using water for essential household purposes. 
• Large user tariffs (for water and sewerage): the Director considers that large user tariffs should be set with reference to the continuing cost of augmenting supply, or long run marginal cost (LRMC) in order to provide for proper incentives.

  This means that large user tariffs may not be expected to come down by the same amount as other tariffs in April 2000. An exception to this might be where any price reduction in the first year of price limits might otherwise cause standard measured volumetric tariffs to fall below large user tariffs.  Large user tariffs could benefit from a reduction which would bring them into line with standard tariffs (ie large users would not be expected to pay more than household customers).

• Charges for trade effluent: under the application of cost-reflective principles trade effluent charges for some water and sewerage companies may need to rise in relation to their sewerage charges.  This is because some companies' charges for sewerage services are generally too high in relation to trade effluent charges (see the 1999-2000 Report on tariff structure and charges, Table 23).   This will limit the scope in 2000-2001 for possible reductions in trade effluent charges in some companies.

3.2 Timing and methods of payment

All companies currently offer a range of methods for payment by cash or other means such as cheque or direct debit. All companies also offer some free payment facilities at either banks, post offices, offices of the local council or water company or through PayPoint. However the precise arrangements vary between companies and some restrictions may apply.
For customers having difficulty in paying their bills the Direct Payment Scheme whereby payments are deducted from benefits is an important facility.

The timing and range of payment methods offered by each company is one of the aspects of performance assessed in the recently introduced overall performance indicator. The Director intends to make adjustments to price limits to reward or penalise those companies providing services to their customers which are significantly better or worse than the industry average. The Director and the Customer Service Committees (CSCs) will continue to monitor services and encourage best practice across the industry.

There are strong incentives on companies to establish customer friendly payment methods which facilitate effective revenue collection, particularly in the light of the forthcoming prohibition of disconnection. It might be argued that these incentives are sufficient to ensure companies establish a reasonable range of payment methods which meet the needs of different customer groups, and that the Director need not set out detailed service standards. However, on balance, the Director believes it would be helpful to set out clear minimum requirements which companies should meet.

The Director's proposals

The Director considers that companies' charging schemes should set out clearly their policies on the timing of bill payment and the methods by which payment may be made. Such policies must take account of the different circumstances of customers, particularly those on low incomes who may find it more difficult to pay their bills.

For timing, the Director considers that companies should provide, as a minimum, the following arrangements:

• Charging schemes should set out details of the payment arrangements available to both metered and unmeasured household customers and to business customers. These details should cover available options for the frequency of payments eg, weekly, monthly, quarterly, half-yearly or annually.
• Many customers will find it easier to budget if they are able to spread their bills more evenly through the year.  Both metered and unmeasured customers should be able to spread payment of their bills throughout the year.
• Companies should make provision for weekly or two-weekly payments, and be prepared to consider requests for special arrangements from customers having difficulty paying their bills (eg frequent payments of variable amounts).
  
  For methods of payment, the Director considers that companies should provide, as a minimum, the following arrangements:
• Companies should offer a reasonable range of payment methods taking account of the needs of different groups of customers such as those with no bank account.
• Companies should make provision for cash payments which are free of charge and at locations which are reasonably accessible to customers.
• Companies should commit themselves to using the Direct Payment Scheme in appropriate cases and note this in their charging schemes.

3.3  Metering

Optional metering

The Water Industry Bill will give all household customers the right to request the installation of a meter, free of charge, when it is enacted.   Companies would refuse such requests only if it is impractical to install a meter or its installation would involve unreasonable expense. Any disputes about practicality or unreasonable expenses would be determined by the Director. Customers who opt for a meter would be entitled to revert to the previous method of charging up to 12 months after the installation of the meter. The Bill would require companies to include their time-scales for responding to requests for meters in their charges schemes.

Balancing customers' interests

Customers who opt to be charged on a measured basis are likely to do so because it will lead to a reduction in their bill, without any change in their consumption.  The consequent loss of revenue to the company will in part be made up by increased charges to customers remaining on an unmeasured basis. At the time of Prospects for prices companies were forecasting that the rate of switching in 2000-2005 would be around 4% each year.  Ofwat estimated that this could result in bills for customers remaining on an unmeasured basis increasing by an additional 1½-2½% a year.   This would be inconsistent with the objective of predictable increases in bills.   If bills are to be predictable for customers, then with unchanged water use bills should not rise significantly out of line with changes to the overall company price limits.

A generous interpretation of the concept of "reasonable expense" will help individual customers but will increase the costs of operating the new optional meter schemes, which will have to be borne by customers generally. Similarly it is important that the programme of meter fitting is managed as cost effectively as possible in the interests of customers generally.

The Director's proposals

Overall, the Director considers that the preferred balance lies in a package of measures which reflects the principle of an entitlement to a free meter but seeks to manage the pace of change. The Director's proposals on how he expects companies to achieve this are set out overleaf:

1 (Un)reasonable expense and impractical circumstances.

In practice issues of practicality are issues of expense since in most circumstances it will be possible physically to install a meter.  The central question is, therefore, what is a reasonable expense?  One approach would be for the Director to set a limit on costs above which a company would be entitled to refuse to install a meter, although it would be free to meet costs above that limit.  The drawback is that there would be inevitable disputes about the costs of works which are not easy to resolve.

The Director prefers an approach which defines the expenses which should be met by companies, and those which it would not generally be reasonable for them to meet and which, other than in quite exceptional circumstances, could be considered as unreasonable. 

Ideally, the Director would like to see customers have the choice of meeting the cost of works which would normally be considered unreasonable, so that all customers would benefit from the new entitlement.  However, Department of the Environment, Transport and the Regions (DETR) has indicated that this would be specifically precluded by the Bill and where the total costs are judged to be unreasonable, the customer cannot switch to a meter.

• The Director considers that reasonable expense would include:

• The Director considers that unreasonable expense could include:

• The Director considers that for customers in multi-occupied buildings, companies should be willing to consider requests for a meter for the building, provided all the customers agree to a single bill with the landlord/agent or residents' association taking responsibility for its payment. 

• The Director believes that the starting principle should be that companies choose the location, subject to the customer being able to read the meter. However, in assessing the costs of the provisions of the Bill, for the purposes of the 1999 Periodic Review of price limits, the Director is minded to assume that generally companies will install meters externally where there is an existing meter box, but otherwise will install them internally.
• The Director considers that, subject to the above, the issue of choice of location should be left to companies to decide as part of developing an optimal package for minimising installation costs; managing supply pipe leakage; and minimising meter reading costs.
• The Director believes that, subject to the above, customers should be offered a choice of location if they are prepared to meet the additional costs of installation over and above those deemed reasonable (as set out in point 1 above).

• The Director believes that companies should set out their proposed installation times striking a balance between minimising the costs to be borne by the generality of customers, and providing individual meter optants with a prompt service.  Before accepting lengthy timescales the Director will need to be satisfied that there are genuine cost advantages in doing so.

• The Director believes that no company should allow reversion to unmeasured charges after the 12 months statutory entitlement. 
• The Director considers that companies will need to set out in their charges schemes what happens if they are unable to meet the timescales for installation.  Because companies may only charge household customers in accordance with an approved charges scheme then strictly if the approved timescale for installation is exceeded they lose the power to charge the customer anything - unless provision for such circumstances is included in the scheme.  The Director considers that the principle is that customers should be no worse off because of any delay.   Accordingly, companies should include arrangements to ensure that that principle is met.

• The Director does not consider that the requirement to pay metered charges by particular payment methods - such as direct debit - is consistent with the provisions of the Bill. This understanding would also apply to survey fees, whether refundable or not.

The Bill would give the right to any customer to have a meter installed and to be charged on a measured basis. Ministers have indicated, however, that where it is unreasonably expensive or impractical to install a meter, customers should not be obliged to remain on their current unmeasured charge. Customers should have the possibility of an alternative charge such as an assessed measured charge.

At present, three companies operate assessed charging schemes for customers where it is not practical for a supply to be taken through a meter and Rateable Value (RV) based charging is no longer considered appropriate. Two companies have assessed volume charging schemes for household properties, either by type of property or by the level of occupancy.

• The Director considers that all companies should introduce assessed household charges schemes where a customer wants a meter but the property cannot be metered on grounds of practicality or of cost.

Experience to date suggests that the rate of customer take-up of meter options is affected by the way in which companies promote and market their meter option schemes.  The Director has already stated that he considers that too rapid a rate of tariff switching will act against the interest of remaining unmeasured customers.

The Director therefore considers that companies should develop their approach to the promotion of optional meters as follows:

• All customers should be made aware of the entitlement and this could be achieved by clear reference to the meter option on every unmeasured bill, together with a telephone number/address for further details. 
• The Director does not expect companies to engage in extensive promotion of the free meter option if doing so would lead to significant increases in bills for unmeasured customers. 
• The Director believes, however, that companies should be active in bringing the entitlement to the attention of customers who may face difficulties paying their bills and who could benefit from moving to a measured charging basis.

Selective metering

Subject to the Regulations to be issued by the Secretary of State, companies should set out in their charges schemes details of how they intend to use their continuing powers to meter household and non-household customers.

4. THE APPROVAL PROCEDURE

4.1 Proposed timetable

The proposed timetable for the approval of water companies' charges schemes was set out in the 1999-2000 Report on tariff structure and charges and is subject to a separate consultation process. The closing date for responses to the timetable proposals is 30 June 1999. 

The proposed timetable as noted above, and the proposed process for implementing the approval procedure, are summarised in Figure 4.1 below.

Draft guidance and draft Regulations are expected to be published by the Secretary of State in summer 1999 and autumn 1999 respectively.

During July 1999, Ofwat will meet with the companies and the Customer Service Committees to discuss the proposed approval procedure and the Director's proposals on charging policies for 2000-2001.

The Customer Service Committees will play a key role in the approval procedure.  They will be involved in early discussions with the companies as well as being invited to submit written comments on companies' draft charges schemes.

A similar timetable will be used for the process of approving water companies' charges schemes for the year 2001-2002.

Figure 4.1  Proposed timetable 1999-2000

Date	Approval process
During July	Summer Tariffs meetings, to include Customer Service Committees (CSCs)
by 13 August	Responses to this consultation received
by 3 September	Conclusions to this consultation published
by 30 September	Draft charges schemes and major new tariff proposals received
by 31 October	Written comments from CSCs on draft charges schemes received
During October and November	Autumn Tariffs meetings
by 15 December	Written feedback to companies
by 30 December	Feedback to CSCs
by 31 January	Principal Statements and provisional charges schemes submitted
by 28 February	Charges schemes approved
by 1 April	Charges schemes published
by 15 April	Published charges schemes received by the Director
by 31 May	Review of charges schemes completed

4.2 Critical dates

The critical dates for implementing the approval procedure are:

• 30  September 1999 for the submission of the draft charges schemes (with a provisional set of individual charges), and major new tariff proposals;
• 15 December 1999 for formal feedback to the companies on their draft charges schemes
• 31 January 2000 for the submission of charges schemes for the Director's approval; and
• 28 February 2000 for formal approval of charges schemes for 2000-2001.

The approval procedure is expected to be split into four stages - each being triggered by the critical dates set out above.

Stage 1: Check draft charges schemes and assess major new tariff proposals

Draft Charges Scheme: The draft charges schemes should be received by the Director by 30 September 1999. The format and the content of the draft charges schemes will be checked in October and November 1999.  A current best practice approach to charges schemes is attached at Appendix C.

Major New Tariff Proposals: The Director should also receive any proposals for new tariffs (for the forthcoming charging year) by 30 September 1999. The Director will not consider major changes to the charges scheme without being given sufficient time to consider them.

Stage 2: Formal feedback to companies (and CSCs)

Following formal meetings with the companies in the autumn and the receipt of written comments from CSCs on the draft charges schemes the Director will provide written responses on the draft charges schemes to companies (and the CSCs).

Stage 3: Formal approval of charges schemes

The provisional charges schemes will be submitted to the Director for approval along with Principal Statements by 31 January 2000. Ofwat will also check that the charges schemes comply with Condition D of the Licence (see Appendix   A).

Stage 4: Review of published charges schemes

The published charges schemes should be submitted to the Director by 15 April 2000. These will be reviewed to confirm that all charges listed in the published charges scheme are as approved by the Director in Stage 3.

Appendix A: THE CURRENT LEGAL FRAMEWORK

1. The Water Industry Act 1991

Charging obligations

Under Condition E of the Licence (see below) companies are required to avoid undue preference/undue discrimination in the setting of charges to customers.

The principal statutory duty of the Director under Section 2 of the Water Industry Act 1991 with respect to charging is the avoidance of undue preference and undue discrimination in the setting of charges to customers. 

Content of charges schemes

Section 143 of the Water Industry Act 1991 states that charges schemes are to contain:

· the level of charges to be paid; and

· the times and methods of payment of these charges.

For the purposes of checking price limits, charges, as defined in Condition B of the Licence (see below) may include both standard and excluded charges.

Charges normally included in companies' charges schemes include those for: measured customers, unmeasured customers, trade effluent dischargers, connection and access to the infrastructure, and other miscellaneous items.

Exclusions to charges schemes

There are a number of charging areas which are not required to be included in charges schemes.

Connection charges: Connection charges, as opposed to infrastructure charges, are not required to be included in company charges schemes. Under Section 45 Water Industry Act 1991, companies have a separate entitlement to recover "expenses reasonably incurred".  These charges are not therefore the subject of the Director's power to approve charges schemes.

Cesspool and septic tank charges: Provision of services for tankered waste is not part of the functions of an undertaker under the Water Industry Act 1991.  It follows that these charges need not be included in a charges scheme and therefore will not be the subject of the Director's approval.  For the sake of completeness, however, companies may include these in their charges schemes as they do at present.

Metering policies

Companies, at present, generally set out their policies in respect of metering both where they offer an optional metering scheme and where they have policies to meter household and non-household use, eg those households with water sprinklers. Companies would also be required, under the Water Industry Bill (the Bill), to set out their timescales in respect of the provision of optional meters.

2. The Licence

The Licence or the Instrument of Appointment imposes conditions on water and sewerage companies (the companies) which the Director is required to enforce. The Licence currently consists of separate conditions (A to Q) - including Condition D on Charges Schemes (their content), Condition E on Prohibiting Undue Discrimination (and Undue Preference) in Charging, Condition B on Charges (ie price limits and the tariff basket) and Condition G and H on relevant Codes of Practice.

Condition D requires companies to fix and publicise their charges for (domestic) water and sewerage services and new (domestic) "connections" (as defined by Section 146 (2) of the Water Industry Act 1991). The companies have a duty "to ensure that (for the charging year which begins on 1 April) …. there is in effect a charges scheme in accordance with Section 143 (of the Water Industry Act 1991)" to do this.

Condition B sets out the formula for calculating price limits. It also defines standard and excluded charges. Indeed, for the purpose of estimating price changes, a standard charge includes - amongst others - any charge that is fixed under a charges scheme (as referred to in Section 143 of the Water Industry Act 1991).

Condition E requires that companies - in fixing or agreeing charges - should "ensure that there is no undue preference shown to, and that there is no undue discrimination against any customer or potential customer". The Director may request information to satisfy himself that the Appointee is complying with this condition.

Condition G requires the approval and publication of codes of practice describing their policies on - amongst others - charges, billing arrangements and meter reading.

Condition H requires publication of a code of practice on debt and disconnection.

Condition M requires companies to provide the Director with information that he may reasonably require.

3. The Water Industry Bill

Part I of the Bill - on water charging in England and Wales - will have an important impact on the charging policies for the water and sewerage companies in England & Wales when it passes into law. The Bill includes the following important provisions relating to charging:

• it provides for the approval by the Director of water companies' charges schemes;
• it provides for the content of charges schemes (through Regulations - as prescribed by the Secretary of State);
• it gives the right to the customer to opt for a measured charge (with an option to return to unmeasured basis within 12 months), and to have a meter installed free of charge;
• it restricts the power of the company to meter existing unmeasured customers (unless conditions in Regulations are met, or as a result of a complete change in occupation);
• it prevents companies from charging their household customers by other than an approved charges scheme;
• it extends the right to use rateable values for charging unmeasured customers  beyond March 2000; and
• it prohibits disconnections (for non-payment), and the use of limiting devices for household customers and in certain other defined premises (eg hospitals and schools).

4. Competition Act 1998

This Act will take full effect on 1 March 2000.   Under it, the Director will have powers, concurrent with the Director General of Fair Trading, to investigate and deal with its prohibitions of anti-competitive agreements and conduct, and of abuse of a dominant position.  A consultative draft of a guideline showing how these concurrent powers might be applied to the water and sewerage sector will be published shortly.

Pending the outcome of that consultation the Director believes that it will be sensible for him to keep in mind his new powers under this Act when deciding whether to approve charges schemes.

For example, the justification for a particular charge might primarily raise questions of cost-reflectivity and the possibility of undue discrimination or undue preference.  However, he will also consider whether particular charges, either as they stand or in conjunction with associated non-price terms, may be in breach of either of the new prohibitions.  (It is likely that the more material one will be the prohibition of abuse of a dominant position.)  In such a case, the Director would require reconsideration of the charge, as part of his pre-approval dialogue with the company, rather than wait to re-open the issue once the approved charges have been applied (from 1 April 2000).

Once charges schemes have been approved, the Director would not normally expect to re-open any of their contents before the companies have submitted their proposed charges for the following year. It might, however, be appropriate to do so, if it appeared that the application of a tariff was different from his understanding when approving it, or if a company had departed from it - for example, by reducing the charge to particular customers where a new threat of competition had emerged.

Appendix B: POLICIES FOR COST-REFLECTIVE CHARGING

1. The balance between water and sewerage charges

Fairness between water and sewerage charges is achieved if the share of total revenue which companies gain from each service equals the share of total costs incurred in providing each service. It is the Director's view that the best basis for achieving a fair balance between water and sewerage charges is for water and sewerage companies to equalise the rates of return on capital employed in each service. Rebalancing between water and sewerage charges should be on the equalisation of the expected rates of return earned on regulatory capital value rather than Modern Equivalent Asset values.

The Director intends to continue with the practice of setting a single K factor for water and sewerage companies rather than separate water and sewerage service K factors. When the Director sets price limits as part of the 1999 Periodic Review he will, however, publish an indicative split of Ks for each water and sewerage company indicating the desired relative movement of charges for each service. These will be announced on 27 July 1999 as part of the Director's draft determinations.

2. The balance between measured and unmeasured charges

The Director expects any difference, on average, between measured and unmeasured bills to be no greater than the extra costs of providing a metered service. This measured/unmeasured tariff differential is calculated by applying the company's measured charges to the average amount of water delivered by that company to an unmeasured household and comparing the resulting measured bill with the average unmeasured household bill for that company.

Ofwat has calculated the additional costs of metering to be no more than £30 a year in 1999-2000 prices for water and sewerage services together. These additional costs are the customer-related metering costs (such as meter reading and billing) and the costs of benefits received by metered customers but not by unmeasured customers (such as the cash flow effect and rebates on supply pipe leakage). Anything more than a total of £30 implies a cross-subsidy from measured to unmeasured customers. The Director believes an appropriate split of the costs between water and sewerage services to be two-thirds water to one-third sewerage. The tariff differential for water should, therefore, be no more than £20 a year, and for sewerage no more than £10 a year, in 1999-2000 prices.

3. The balance in charges between those related to use and those reflecting  customer-related costs

In order to give sensible incentives, measured tariffs should be structured so that, as consumption increases or decreases, resultant changes in costs incurred by the company are reflected in customers' bills. The most appropriate way of achieving this is to set the volumetric rate to reflect the costs which companies would incur over the longer term in meeting demand from measured customers. High standing charges lessen the incentives for customers to control their consumption and, therefore, their bills. In the past, high standing charges were common. The Director believes, however, that standing charges should recover no more than those costs relating to the number of customers.

The Director considers that, generally, the total measured standing charge for water and sewerage should be no more than the annual customer-related costs for unmeasured customers plus the additional costs of metering. As outlined above, the Director estimates the additional costs of metering to be no more than £30 in 1999-2000 prices for water and sewerage. The annual customer-related costs for unmeasured customers have been estimated to be no more than £7 in 1999-2000 prices. Hence, the total measured standing charge for water and sewerage should be no greater than £37 in 1999-2000 prices. Using the two-thirds/one-third split for water and sewerage, the measured standing charge for water should be no more than £25, and for sewerage no more than £12.

The Director has also encouraged companies to reduce non-household measured standing charges. These charges should be set on the same principles as household standing charges, ie they should recover customer-related costs only. These costs may be legitimately higher where non-household users are billed more frequently and because larger meters are more expensive to maintain and replace.

4. Sewerage, surface drainage, highway drainage and trade effluent charges

Charges for surface and highway drainage

Surface and highway drainage is a complex area of charging policy and there are a number of difficulties associated with the recovery of the costs of providing these two services. The costs of surface drainage are generally dependent on the surface area of the property drained and the nature of surface water run-off, as well as the capacity and extent of the sewerage system. The Director continues to encourage companies to achieve a better understanding of the costs attributable to surface and highway drainage.

Many customers are not aware that they pay a charge for surface and highway drainage. The Director wants to see more transparency in the way that customers are billed. He has asked companies which charge for surface (and highway) drainage through a fixed charge to show it separately on their bills and has also asked all companies to provide, at the very least, an explanation of the charges on their bills.

In principle, all customers who can demonstrate that they do not receive a specific sewerage service should be entitled to an appropriate abatement of charges. Therefore, when customers are not connected for foul drainage, they should not pay the costs of the provision of foul drainage and similarly, when they are only connected for foul drainage, charges levied by companies should not cover surface drainage. In such circumstances, the Director would like to see companies provide abatements in charges if a customer can demonstrate that the property concerned does not benefit from surface drainage.

Trade effluent charges

Charges for trade effluent are based on the Mogden formula, which seeks to link charges to the costs imposed by customers, ie by paying according to the volume and strength of trade effluent discharged. The Mogden formula generally charges for trade effluent with respect to the costs of each individual element across a sewerage company's area. It takes account of the standard characteristics of a customer's discharges which relate to the level of treatment needed and therefore the costs involved.

The Director accepts that any such changes to Mogden charges can be justified if they result in a charging formula which better reflects the costs involved in treating trade effluent. He requires robust calculations of the cost-reflective level for the Mogden charges to allay fears that companies could be engaging in predatory pricing.

Some customers discharging weak effluent have concerns, shared by the Director, that they are being overcharged for this service. Companies need to apply a cost-reflective approach to this issue by making a correct balance between the elements of the trade effluent charge.

The Director wants to see an appropriate balance between the charges levied for trade effluent and domestic foul sewerage. The assessment of balance is based on a simple test. If charges for measured sewerage and trade effluent services are broadly in balance, then a comparison between the measured sewerage charge for domestic foul sewerage and a notional trade effluent charge for a similar volume and strength of domestic effluent should produce similar indicative charges. Thus, for a given volume of effluent, differences in bills for domestic and trade sources should be related to differences in strength. Alternatively, for effluent of a given strength, differences in bills should only reflect any difference in the volume of effluent.

The measured sewerage/trade effluent differential is calculated by subtracting the notional trade effluent charge from the measured sewerage charge. A positive differential suggests that charges to measured sewerage customers are too high when compared to charges to trade effluent customers. Likewise, a negative differential suggests that charges to trade effluent customers are too high when compared to charges to measured sewerage customers.

5. Large user tariffs and the design of tariffs for discretionary use of water

Large user tariffs

Companies have examined their cost structures to ensure that charges broadly reflect the costs of supply and to reduce the risk of losing customers to competitors through inset appointments. In response to this competitive threat, companies have reviewed cost allocations between customers and developed tariffs for large user water customers that more accurately reflect costs.

The principles underlying large user tariffs are:

• unit charges should not be lower for business customers simply because they use a large amount of water;
• charges should reflect the lower costs of delivering large quantities of water to a single point of delivery, which does not require the use of all levels of the distribution system;
• tariffs should be structured to avoid incentives to waste water; and
• any separate tariff should be published and made available to all customers in similar positions, rather than by special agreement.

Alternative measured tariffs

It is important that measured bills reflect the cost imposed by the customer, so that the customer is given the correct price signals. This may, for example, lead to bills that are higher if more water is used or if the water is used over peak periods. Customers should have an incentive to be efficient in their use of water. The Director believes that where metering is used as a tool for demand management, there should be an appropriate tariff structure in place. A policy of metering combined with a high standing charge and a low volumetric rate will not allow customers to influence their bills significantly and will not provide an incentive to save water. As metering becomes more widespread, companies may need to examine more sophisticated tariff structures.

Appendix C: CHARGES SCHEMES - CURRENT BEST PRACTICE

In a letter to the companies in May 1997 Ofwat set out what it considered should be the content of a company's charges scheme. A 'best practice' charges scheme would include all of the elements listed below.

The current guide does not take account of the new rights that customers will have once the Water Industry Bill becomes law. This 'best practice' guide will be re-issued and updated by Ofwat in September 1999.

1. Details of charges

• Contain all charges including tariff basket charges, septic tank and cesspool charges, infrastructure charges, domestic connection charges and optional meter installation charges.
  Provide a summary of charges eg in a table format.
• Explain how a customer's bill is calculated ie for unmeasured customers it comprises a fixed charge and a rateable value charge.
• Set out any liability for VAT.

• Detail the level of the return to sewer assumption.
• Set out how the return to sewer assumption is applied to measured sewerage charges.
• Explain the different elements of the sewerage tariff and the basis on which they are charged.  This should indicate the level of abatement of charges for customers who do not receive particular services or who pay surface drainage charges to a third party.

• Include a statement of the level of the infrastructure charge.
• Provide an explanation of the 'relevant multiplier' and how this is used to calculate the level of the charge.
• Explain the arrangements for the payment of the infrastructure charge in instalments and in particular when it is due.

• Provide detail on when charges apply and when payment is required for both measured and unmeasured supplies.
• Identify the different payment options available eg by post, direct debit and at a bank.

• Set out the procedure for collecting outstanding charges.
• Set out the disconnection policy (which groups this applies to).

• Set out the details of the company's meter option scheme and the right of customers to opt for a meter.
• Identify any restrictions that apply to the meter option ie the locations where a meter will not be fitted.
• Where the company will not fit a meter free the appropriate charges should be set out.
• Explain how to apply for a meter ie the contact point for customers.
• Indicate the time scale in which the request for a meter will be responded to and when the customer will begin to pay on a measured basis.
• Indicate whether a customer that has opted for a meter can revert back to paying charges on an unmeasured basis.

• Set out the circumstances under which household/non-household customers will be metered.
• State whether the customer has to pay for a meter installation at the company's option.

• For example, a definition of premises.

• Refer to the procedure in place if a customer is dissatisfied or has a complaint they wish to pursue. 
• Inform customers of the internal complaints procedure in place including contact details.
• Refer to Ofwat's Customer Service Committees (CSCs) or the Director General of Water Services' ability to determine disputes about charges.  Include the contact point of the local CSC. 

• Provide customers with a Scheme that is written in a clear and easy to understand style.
• Where a Scheme is written in legal/technical language include an easy to understand summary which is written in a more customer friendly style eg in the form of additional leaflet or booklet.
• Include a contents page for ease of reference.
• Include a map of the area served.

Appendix  D: GLOSSARY

Guaranteed Standards Scheme (GSS)

A scheme under which the Government has laid down minimum guaranteed standards of service to customers for the companies. Customers are entitled to compensation if companies fail to achieve them; many payments are now made automatically.

Infrastructure charges

Paid by developers and customers in new properties for either a first time connection of premises for domestic purposes to a public water supply or to a public sewer.

Licence conditions

Companies operate under licences granted by the Secretaries of State for the Environment and Wales, or by the Director, to provide water and sewerage services in England and Wales. The licences impose conditions on the companies that the Director is required to enforce.

LRMC (Long run marginal cost)

Long run marginal costs can be defined as the additional cost imposed on a water or sewerage company in supplying or treating each additional cubic metre of water (or wastewater). LRMC will comprise operating and capital costs. It can also be thought of as the continuing cost of augmenting supply (or treatment).

P0 adjustment

A component of the price limit. For the 1999 Periodic Review, the P0 adjustment is a reduction in prices from 2000-2001, the first year of the five for which price limits will be set.

1999 Periodic Review

The 1999 Periodic Review is the process by which the Director resets the water companies' maximum price limits in July and November 1999. The price limit against which water companies can charge is based on a formula of inflation (RPI) plus a factor called K, which is different for each company. In the 1999 Periodic Review K factors, and hence price limits, will be set by the Director for each of the five years from 1 April 2000 to 31 March 2005.

Principal Statement

An annual audited statement to Ofwat that gives details of the charges that a company proposes to set, and shows that, on average, changes in standard charges will not exceed the price limit set. It provides information to enable Ofwat to check that companies' charges are not in breach of Licence Condition B or Licence Condition E.

Regulations

Under the Water Industry Bill, the Secretary of State has the power to make Regulations that the water companies must comply with, once the Bill becomes law. In particular Regulations will specify the protection in charges schemes to be made available to vulnerable groups.

Standing charge

Water and sewerage tariffs for customers taking metered supplies have two elements - a standing charge, which is the same for all customers on the tariff, and a volumetric charge, which varies depending on how much water is consumed.

Tariff switching

Customers can either pay for their water on the basis of how much water they consume (measured or metered charging) or on an unmeasured basis (normally based on the rateable value of the property). Tariff switching takes place when customers change from unmeasured to measured charging.

Appendix E: LIST OF CONSULTEES

Organisations representing customer interests
Age Concern England
Association of British Chambers of Commerce
Chartered Institute of Purchasing and Supply
Chemical Industries Association Ltd
Child Poverty Action Group
Confederation of British Industry
Confederation of British Industry, Wales
Consumers' Association
Food and Drink Federation
Help the Aged
Institute of Directors
Major Energy Users Council
Money Advice Association
National Association of Citizens Advice Bureaux
National Campaign for Water Justice
National Consumer Council
National Council for one Parent Families
National Federation of Consumer Groups
National Federation of Small Businesses
National Federation of Women's Institutes
Ofwat Customer Service Committees
Public Utilities Access Forum
Save the Children Fund
Utility Buyers Forum
Waterwatch
Welsh Consumer Council

Other government departments
Department of the Environment, Transport and the Regions
Welsh Office
Welsh Assembly

Water companies
Water and sewerage companies
Water companies
Water UK

Quality regulators/environmentalists
Council for the Protection of Rural England
Council for the Protection of Rural Wales
Countryside Commission
Countryside Council for Wales
Country Landowners' Association
Drinking Water Inspectorate
English Nature
Environment Agency
Friends of the Earth
Institute of Hydrology
National Farmers' Union
Royal Horticultural Society
Royal Society for the Protection of Birds
Surfers Against Sewage
UK Round Table on Sustainable Development

Trade unions
TUC
UNISON

Members of Parliament
All Party Water Group
Liberal Democrat Spokesman on the Environment
Shadow Secretary Environment, Transport and the Regions

Members of Welsh Assembly

Local government organisations
Local Government Association
National Association of Local Councils
Welsh Local Government Association