Today’s electric grid is facing multiple challenges that require increased levels of utility investment. At the same time, the affordability crisis is putting pressure on utilities and regulators to limit cost growth and avoid unnecessary spending. The challenge of balancing these dual objectives highlights the limitations of the traditional cost-of-service regulatory framework, particularly its weak incentives for operational and investment efficiency, and the ability for utilities to shift risk to customers, including risks arising from poor utility fiscal management.

Multiyear rate plans (MRPs) are a ratemaking approach that can help balance the need for ongoing investments with stronger incentives for the utility to spend more efficiently. When designed well, MRPs have the potential to limit utility cost growth more effectively than traditional cost-of-service regulation.

However, the strength of an MRP’s cost-containment incentive is heavily dependent on several design choices. Many MRPs in the United States are implemented in ways that stray from the original intent of the framework, resulting in outcomes comparable to — or even worse than — those associated with traditional cost of service regulation. By contrast, well-designed MRPs have tremendous promise to enhance affordability, support utility financial stability, and advance a host of other regulatory and policy objectives.

This jointly authored report by RMI and Synapse Energy Economics is intended to help regulators and stakeholders recognize MRP design choices to avoid and remedy existing MRP design flaws. The report identifies three common characteristics associated with flawed MRPs:

1. Weak cost-containment incentives may offer utilities excessive revenues that result in customers paying more than is reasonable, while providing an illusion of cost efficiency.

2. An imbalanced allocation of risk means customers bear risks that should remain with the utility as the entity with decision-making control.

3. Multiple avenues for cost recovery outside of base rates allow the utility to selectively pursue the most favorable cost recovery mechanisms to maximize their earnings.

Each of these characteristics correspond to one or more specific design “pitfalls.” When these pitfalls are present in MRPs, affordability will remain an elusive goal.

This report can help state regulators and stakeholders understand why each MRP pitfall is detrimental to customer affordability, identify when they are present, and evaluate different remedies and design improvements.