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The Cost of MMWD Water Supply Insurance
Introduction:
Let's approach the MMWD long-term water supply challenges from an insurance framework.
How much does MMWD would need to charge in premiums to provide acre feet of water per year (AFY) during dry years?
Introducing the insurance framework
In a standard insurance situation, a homeowner pays a premium to an insurance company to cover a specific risk (fire, earthquake, etc). In return, the insurance company pays the homeowner when he experiences a covered damage and files a claim.
Currently, most of us pay between $1,250 and $2,500 for homeowner's insurance covering fire. And, we pay about the same to cover earthquake risk.
Given that we can get insurance to cover fire and earthquake insurance, could we get insurance to cover drought? It turns out, we could. Let me explain...
The insurance framework would be the same as the standard one. As the diagram shows below, the homeowners would pay a premium to a water supply insurer [a desalination plant]. And, in exchange for the premium that finances the desalination operation, the latter would generate water (AFY) for the homeowners during drought years.
The desalination plant makes for the best water supply insurer. Desalination is the most independent source of water as it does not depend on rainfall, reservoir levels, and river flows.
Another potential water supply insurer is a water recycling plant. However, water recycling is affected by water use. During drought years, we conserve and use less water. And, this may affect the water available for recycling. However, we will still look at both desalination and water recycling plants as viable water supply insurers.
Desalination plant as a water supply insurer
In the table below, I replicate some of the math included in the MMWD presentation on June 18, 2024 (see pdf attached at the end of this essay).
If we focus on the second column from the left, it maps out the cost of a 5-MGD desalination plant that generates 5,601 AFY. That's the AFY coverage it provides. Such a plant is associated with a capital cost of $273.9 million, yearly debt service of $15.3 million, O & M costs of $13.4 million. Thus, the total cost of running this plant is $28.7 million per year. For the coverage of 5,601 AFY, the insurer [desal plant] would charge a premium of $463 per account. The latter is pretty reasonable compared to homeowner's insurance.
The desalination plant generating capacity is really backup capacity. So, what are the costs of maintaining the desalination plant when we do not need extra water? The related additional math is shown below.
The desalination plant is associated with O & M fixed costs of 20% of total O & M costs. Even in downtime, it has to be run at 25% of full capacity. And, those 25% are variable costs based on volume. Thus, in this base case scenario, the O & M costs of maintaining the desalination plant represent 40% of such costs when it is running at full capacity.
Fixed O & M cost + 0.25(1 - Fixed O & M cost) = Total O & M Cost as a % of Total O & M Cost when running at full capacity.
20% + 25%(1 - 20%) = 40%
As shown on the last line of the above table, the premiums per account are much lower than when running the desalination plant at full capacity.
Water recycling plant as a water supply insurer
The math for water recycling is the same. Only the specified inputs and resulting outputs change. Below is the math when running the water recycling plants at full capacity.
Now moving on to figuring out the cost of running the water recycling plants during the off years, when we do not need the water.
Water supply insurance options
We compare the premiums and AFY coverage levels for the 6 different water supply insurance options. These include three desalination plants and three water recycling plants.
The desalination plant 10-MGD is highlighted because it seems to be the optimal water supply insurance option. It is associated with a yearly premium at full capacity of $650 for an AFY coverage of 11,201 (that's over 50% of the MMWD yearly demand for water). This desalination plant offers 43% more AFY coverage than the two water recycling plants (AFY 7,840) that charge very similar premiums ($560 and $633).
The graph below visualizes how much more AFY coverage the desalination plant offers for a similar premium level vs the two water recycling plants.
Premium structure for the 10-MGD desalination plant
The premium structure would have a fixed component to cover the cost of maintaining and running the plant during the off years when we have enough water. This fixed component would be $439 per year.
The premium would have a variable component that is volume-driven. If the plant runs at full capacity (100% volume), the total premium would be $650. This would include the fixed component of $439 and a variable component of $211. For any volume between 25% (minimum to keep the plant functioning) and 100% (at full capacity), the variable component would vary in a linear fashion using the math presented earlier in this essay.
Adopting this insurance framework would resolve our ongoing water supply challenges at MMWD. As we know, our existing water infrastructure is inadequate to serve the water needs of our community of over 190,000 residents during unpredictable drought periods.
Water supply insurance remedies this situation at a reasonable cost. As demonstrated, the resulting premiums are pretty reasonable compared to what we pay insurers to cover fire or earthquake risks.
THE END
Gaetan Lion is an independent researcher with expertise in economics, econometrics, investments, risk management, statistics, and quantitative analysis. His areas of interest include demographics, economics, investments, Climate Change, health care, sports, and politics.