The Appropriate Annuity Period

The pricing and accounting system needs to include appropriate accountability aspects for the assets (as a whole) to ensure the long-term viability of the organization. eg. A full life cycle period (i.e. 100 years).

This is basically required to ensure a fair assessment of all costs is being met by current generations adequately covering intergenerational/equity issues.

The key outcome of any accounting system must be to ensure that the true costs of asset services are allocated to and recovered from those users (customers) who cause the cost.

If we are using an average annual annuity to provide income for the renewal of assets, then the three key impacts will be:

• The discount rate used - i.e. the % used to assess the return on capital
• The period over which the annuity is calculated
• The yearly cash flow required for asset renewals – e.g. the shape of the renewal cash flow.

Any discount rate over 2% will have a significant reducing effect on any annuities over 40 years. That is, all annuities beyond 40 years will have little impact on the average annual annuity and can hence be ignored.

The shape of the cash flow chart is the most critical factor. There is little point in choosing a long-term annuity if the immediate works programs (10 or 20 year) exceed this figure. The money needs to be derived from somewhere.

One option would be to finance the balance of the funds needed. This will be dependent on the organization loan or debt policies. (e.g. no new debt).

To better understand the annuities, it is good to consider them using very low discount rates, so that they reflect annual averages.

This is a critical issue since high discount rates tend to encourage asset owners to defer appropriate intervention opportunities earlier in the asset life. This practice always gives preference to deferring investment till failure or just before failure.

The following diagrams are examples of these variables:

• Mature mid term assets (majority of assets are middle aged)
• Juvenile (young) assets with late renewal profile (majority of assets are relatively young)
• Old age assets with early renewal program (majority of assets are approaching the end of their lives)
• All three examples combined (e.g. different asset groups).

Use of Abatement Factors on Renewal Programs

Abatement factors are often used by asset managers to justify the assumptions behind their programs.

Example

It is assumed that maintenance costs will reduce by 30% over the next 10 years due to efficiencies gained, or we believe that new rehabilitation techniques will allow us to rehabilitate assets at 70% of their lives for less than 30% of their replacement value.

There is considerable opinion in economic circles that the use of abatement factors should be restricted to those benefits that can be clearly identified and represent a currently verified improvement in costs.

It is considered that the future renewal programs must be based on:

• Known and proven technology
• Current construction or rehabilitation costs
• Current maintenance programs or those proven by detailed strategic analysis
• Current or contracted materials and services costs eg. energy, chemicals etc.

One of the key areas involves the assessment of mid cycle intervention techniques including changes in maintenance or the application of various rehabilitation techniques.

Example

By completing special maintenance at 50% of effective lives we can extend the life of the asset by 30%.

Where these indicate a potential benefit to the organization, considerable work may need to be carried out before an appropriate degree of confidence can be determined and the maintenance or rehabilitation programs included in a renewal program and annual annuity.

The degree of confidence will vary as asset owners work through the assessment phase, proving the benefits that could be derived. This may include the following stages:

• Potential benefits are identified through:
  • Outputs of total asset management plans
  • Potential cost savings identified in future renewal programs (25%)
  • Potential cost savings in operations or maintenance areas
• Detailed analysis of potential savings (50%)
• Research and development (R&D) programs completed (65%)
• Pilot schemes implemented and outcomes assessed (80%)
• Results from full scale implementation programs with firm contract rates or detailed costings available (100%).

Note:

Percentages indicate the degree of confidence that can be applied to the abatement factors. It should be noted that with each stage in the assessment programs, the actual value of the benefits derived may change significantly; this will need to be reflected in the future program cost assessments.