Performance-based regulation, commonly called PBR, is an alternative or a modification to cost-of-service (COS) ratemaking. It is sometimes also called incentive regulation. Under PBR, rates for regulated services are set by a formula that provides an opportunity for the regulated firm to increase its rate of return by achieving performance metrics specified by the regulator. The use of PBR is intended to align the financial interests and actions of utilities with public interest goals and consumer benefits. This contrasts it with COS ratemaking where utilities’ earnings are driven by capital investment and authorized rates of return. Under PBR earnings are driven by outcomes (performance against metrics) as opposed to inputs (invested capital and authorized rate of return).
PBR principles can be applied to a portion or all of a utility’s operation. Examples of applying PBR to a portion of the business include:
In some cases, PBR principles are applied to full utility operations. In this case initial rates are typically set through cost-of-service methodology but rather than re-evaluating utility costs to adjust rates, rates are adjusted through a formula. A key aspect of the formula is the utility’s performance relative to metrics. If high-quality performance is achieved, rates are raised resulting in higher earnings. If not, rates decrease resulting in lower earnings.
Examples of potential areas covered by performance metrics include:
As of 2020, numerous regulators have implemented or are in the process of implementing performance-based regulation (PBR) including the states of Hawaii, Illinois, and New York as well as all of the United Kingdom and Mexico.