Recommendations for tariff modelling (Phase 2)

Phase 1 of this study involved a comprehensive review and assessment of various tariff options designed to address the issue of vulnerable and disengaged consumers being penalised by the energy market through higher prices. This assessment used a tariff assessment matrix and expert input from a wide range of stakeholders to provide a robust and objective assessment of the different options.

111 _{Aldridge et al (2012), ‘Monitoring Poverty And Social Exclusion’}

112 _{DWP (2013), ‘Rates Of People Moving From Out Of Work Benefits – DWP Equality Information 2013 (Data)’}

113

DWP (2012), ‘Income Related Benefits: Estimates Of Take-Up In 2009-10.’

114

See footnote 104

115 _{See footnote 105}

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In addition, analysis was undertaken to explore the implications of adopting the CWP eligibility criteria for targeting the tariff options.

The results of this phase of the study provide a firm grounding for the next stage, in which a selection of tariffs are modelled and the impact on the target group and distributional implications are explored. Below, we present the basis for recommendations for the modelling phase, in terms of both the tariffs to be modelled and the approach to identifying the target group.

6.1 Selected tariffs to model

All the tariff options considered in this study have several hurdles, barriers and risks; some significant in nature. Whilst these have been taken into consideration in selecting tariffs for

modelling in Phase 2 of the project, the primary concern is the tariff’s potential to reduce the bills of the vulnerable targeted group. Five tariffs were shortlisted as having potential to reduce target group bills:

 Backstop tariff

 Extension of WHD

 Cap spread of tariffs

 No difference in charge by payment method

 Exemption from levies for certain households

After further consideration, the following were excluded from the quantitative modelling:

 Capping spread of tariffs – this option has a high requirement for new regulation, a high negative impact on competition, and would be complicated to calculate and administer.

 No difference in charge by payment method – similar to the above but with the additional limitations that this solution goes against cross-reflective pricing and its impact (on the target group and wider distributional implications) is highly dependent upon how suppliers respond.

The backstop tariff and extension of the WHD also had negative aspects, but were considered to offer the greatest potential for reducing the bills of the target group, and so were retained for the modelling.

Levies on energy bills have been a subject of considerable public debate in recent years, principally being the subject of criticism in the context of rising fuel prices. However, implementing a tariff exempt from levies for the vulnerable group only scored relatively low in the overall tariff assessment process. In consultation with Citizens Advice, it was therefore decided that a third regulatory intervention option would be included in the modelling that combined the ‘Exception from energy sector levies for certain households’ tariff and the introduction of an RBT. The final option was a tariff structure whereby a block of energy would be exempt from energy and social levies for all households. This was on the premise that low-income households, typically having lower than average consumption, may stand to benefit the most.

The final tariff options selected for modelling were as follows:

 Backstop tariff (targeted at the CWP-eligible group)

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 Exemption from levies for an initial block of energy (including an option targeted at the CWP-eligible group only and a non-targeted, blanket approach)

In modelling the third option, an additional variation was also included that simply offered a free block of energy to households. This was identified through researching European initiatives and was included to represent an option that was similar to the ‘exemption from levies for an initial block of energy’ options, but is potentially simpler to administer.

The next chapter presents the detailed modelling results for these three interventions, including the distributional impacts on all consumers, as a well as a breakdown by ‘winners’ and ‘losers’ and different consumer archetypes.

6.2 Target group

From the evidence presented in Section 5, it has been confirmed that the selection of the CWP eligibility criteria offers a good approach to targeting low-income and vulnerable households who are likely to be disengaged from the energy market and, as a result, paying a higher-than-average unit cost for their energy.

The CWP eligibility criteria include low-income pensioners and low-income families with young or disabled children. This aligns with the general public view that these household types are amongst the most worthy to receive special tariffs (see Section 5.2, page 57). Furthermore, analysis suggests a significant proportion of this group (66 per cent) are likely to have never switched energy supplier (higher than the modelled average rate of non-switching at 50 per cent - see Table 5.2), and as a result, many are likely to be on some of the most expensive tariffs in the market.

However, it is important to recognise that the CWP eligibility criteria do exclude a number of other low-income and/or vulnerable households, including some with members who are over 70 as well as a broader disabled group. This has implications for the distributional impacts of the tariffs, which will be explored through the analysis in Phase 2.

Reliance on proxy measures inevitably prevents ‘perfect targeting’. Broadening the criteria to include a larger proportion of the population could pick up a higher proportion of the preferred target group, but could also arguably be considered impractical and infeasible. Particularly in the context of this project, changing market conditions for a significant proportion of customers will have implications for the market as a whole.

Therefore, while acknowledging that there are some limitations in this approach, the use of CWP eligibility criteria has been deemed to be a useful method to identify low-income, vulnerable households. It has therefore been applied in the modelled targeting and assessment of the impacts of options in Phase 2 of this study.

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