Ofwat resorts to top-down PR24 incentive rates after struggling with customer valuations

Ofwat has abandoned plans to base outcome delivery incentive (ODI) rates at PR24 on evidence gathered from customers through its centralised research programme.

For the majority of performance commitments (PCs), the regulator had planned to use a 'bottom-up' approach to set indicative ODI rates, primarily based on estimates of marginal benefit from the collaborative customer research being undertaken in conjunction with CCW and companies. This sought customer views on the impact and financial value of 26 different service incidents – such as a pollution incident or supply interruption.

The approach was taken to counter problems that arose at PR19 when companies were left to propose their own ODI rates based on customer evidence. Ofwat felt this resulted in unexplained variation.

However, Ofwat reported encountering problems when trying to map the service incidents articulated to customers during the collaborative research onto its PC definitions; it could only do so robustly for half the PCs, and even where this was possible, the regulator felt the resulting valuations were in parts implausible. In a paper, it explained: "Some rates were very low, some implausibly so, and would not sufficiently incentivise companies to improve their performance. Other rates were very high, some implausibly so, and were not consistent with the ±1 to ±3% return on regulatory equity (RoRE) each year that we set out in the final methodology. Further qualitative research supported our concern that these rates significantly exceeded customers’ underlying willingness to pay [WTP].”

It has therefore decided to set all ODI rates using a 'top-down' approach based on equity return at risk – albeit it will use the customer research evidence to assign larger incentives to areas prioritised by customers.

The top down rates were set out in the paper, and companies told to use them in their business plans or provide compelling evidence for alternatives.

Commenting on Linked In, Katy Long, principal economist at Ofgem, called the announcement “somewhat astonishing” and mused: “What remains to be seen is whether companies can convince Ofwat in their business plans that their own customer research is credible/robust enough to replace these initial top-down rates with company specific bottom-up rates in targeted areas. Are we witnessing the death of WTP research and will bottom-up methodologies be sacrificed at the altar of commonality?”