Performance Based Regulation

Rate-of-return regulation rewards utilities for building things. Performance-based regulation rewards them for delivering results.

Performance-based regulation (PBR) replaces or supplements the traditional cost-of-service model with financial incentives tied to measurable outcomes: reliability improvements, emissions reductions, customer satisfaction, or hosting capacity for distributed energy. Instead of earning returns proportional to capital spending, the utility earns bonuses for hitting targets and pays penalties for missing them.

The core problem PBR addresses is the Averch-Johnson effect from rate-of-return regulation: because utilities earn a guaranteed return on capital, they are incentivized to build more infrastructure regardless of whether cheaper alternatives (demand response, third-party storage, non-wires solutions) could deliver the same result. PBR breaks this link by tying profit to performance rather than spending.

Hawaii's PBR implementation. In 2020, Hawaii's Public Utilities Commission adopted PBR for Hawaiian Electric, replacing the traditional rate case cycle. Performance incentive mechanisms (PIMs) include targets for interconnection speed, grid reliability (SAIDI), and DER hosting capacity.

If the utility earns bonuses for faster interconnection but also earns returns on capital spending, what prevents gaming?

The shared savings mechanism. PBR caps total revenue growth and shares efficiency gains between the utility and ratepayers. If Hawaiian Electric finds a non-wires alternative that costs less than a new substation, the savings are split: ratepayers pay less, and the utility keeps a portion as profit. Under traditional regulation, the utility would prefer the substation because it earns a return on that capital.

---