Managing water utility financial risks through third-party index insurance contracts

As developing new supply capacity has become increasingly expensive and difficult to permit (i.e., regulatory approval), utilities have become more reliant on temporary demand management programs, such as outdoor water use restrictions, for ensuring reliability during drought. However, a significant...

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Bibliographic Details
Published in:Water resources research 2013-08, Vol.49 (8), p.4939-4951
Main Authors: Zeff, Harrison B., Characklis, Gregory W.
Format: Article
Language:English
Subjects:
Drought
drought management
economics
index insurance
Regulatory approval
Risk management
Third party
Water utilities
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Summary:As developing new supply capacity has become increasingly expensive and difficult to permit (i.e., regulatory approval), utilities have become more reliant on temporary demand management programs, such as outdoor water use restrictions, for ensuring reliability during drought. However, a significant fraction of water utility income is often derived from the volumetric sale of water, and such restrictions can lead to substantial revenue losses. Given that many utilities set prices at levels commensurate with recovering costs, these revenue losses can leave them financially vulnerable to budgetary shortfalls. This work explores approaches for mitigating drought‐related revenue losses through the use of third‐party financial insurance contracts based on streamflow indices. Two different types of contracts are developed, and their efficacy is compared against two more traditional forms of financial hedging used by water utilities: Drought surcharges and contingency funds (i.e., self‐insurance). Strategies involving each of these approaches, as well as their use in combination, are applied under conditions facing the water utility serving Durham, North Carolina. A multireservoir model provides information on the scale and timing of droughts, and the financial effects of these events are simulated using detailed data derived from utility billing records. Results suggest that third‐party index insurance contracts, either independently or in combination with more traditional hedging tools, can provide an effective means of reducing a utility's financial vulnerability to drought. Key Points Drought has a destabilizing effect on water utility revenues Revenue losses can be modeled and predicted probabilistically Weather derivatives can provide insurance payouts to mitigate revenue losses
ISSN:0043-1397
1944-7973
DOI:10.1002/wrcr.20364