Final Policy Statement

This FHWA policy statement on life-cycle cost analysis (LCCA) helps fulfill Federal management responsibilities for analyzing life-cycle cost aspects of infrastructure investment decisions under Executive Order 12893, ``Principles of Federal Infrastructure Investment.'' The policy statement establishes LCCA principles to be applied by FHWA in infrastructure investment analyses, and provides a framework that States may use in conducting LCCA as required in Section 303 of the National Highway System (NHS) Designation Act of 1995 (P.L. 104-59) or as appropriate for other investment decisions. The importance of considering life cycle costs in various phases of project development, construction, maintenance, and operation is emphasized.

Mr. James W. March, Team Leader, Systems Analysis Team, (202) 366-9237, or Mr. Steven M. Rochlis,

Program Legal Services Division, (202) 366-0780, FHWA, 400 Seventh Street SW., Washington, D.C. 20590.

"Principles for Federal Infrastructure Investment,'' issued on January 26, 1994, notes that ``[a] well-functioning infrastructure is vital to sustained economic growth, to the quality of life in our communities, and to the protection of our environment and natural resources.'' The Executive Order goes on to state that ``[o]ur Nation will achieve the greatest benefits from its infrastructure facilities if it invests wisely and continually improves the quality and performance of its infrastructure programs.'' The first step recommended in the Executive Order is ``Systematic Analysis of Expected Benefits and Cost.'' The Executive Order advises that in performing this systematic analysis, ``benefits and costs should be measured and appropriately discounted over the full life cycle of each project. Such analysis will enable informed tradeoffs among capital outlays, operating and maintenance costs, and nonmonetary costs borne by the public.''

On July 11, 1994, FHWA published an interim policy statement on LCCA in the Federal Register (59 FR 35404). An important objective of that policy statement was to implement life cycle cost provisions of Executive Order 12893. The FHWA also requested comments on potential problems in implementing provisions of the policy and specific needs for training and technical assistance to apply LCCA.

The FHWA received a total of 40 comments on the interim LCCA policy statement. Twenty-two were submitted by or on behalf of State departments of transportation and 18 were submitted by industry groups, consultants, and other private sector organizations. The overwhelming majority of comments expressed the sentiment that LCCA has the potential to contribute to improved investment decisions. Comments on the interim LCCA policy statement primarily discussed two broad areas: implementation of the policy and technical issues in applying LCCA. The comments are summarized below.

Several comments questioned whether a LCCA should be mandated for some or all projects and whether sanctions would be applied for failure to conduct required LCCAs according to the principles set forth in the policy statement. Some commenters, however, supported making LCCA mandatory. Advocates for Auto and Highway Safety, for instance, asserted that ``[o]nly if LCCA is made a condition of funding approval, especially at the individual project level, particularly on the NHS, will this decisionmaking approach gain credibility and also produce the long-term safety and mobility benefits that are naturally generated by selection of high-quality, durable highway and bridge designs.'' The National Asphalt Paving Association declared that ``the Federal Government needs...to take a leadership role in clearly defining a standardized format in which all users apply a uniform solution approach to solve LCCA problems. Unless this is accomplished, analytical LCCA chaos will reign.''

Most comments that addressed the issue, however, were opposed to an LCCA requirement. Many State highway agencies expressed concerns about the potential burden associated with LCCA requirements, especially if detailed analyses were required for all improvements. Several States suggested that thresholds be established below which an LCCA would be optional. Recommended thresholds ranged from $1 million to $10 million.

Other suggestions included requiring an LCCA only on NHS projects or requiring LCCA only for certain elements of a project. Some commenters recommended that the policy statement not establish new LCCA requirements, but rather provide broad policy guidance on principles of good practice. ``FHWA should act in the LCCA area as a valued technical advisor to the States, * * * but FHWA should not force solutions and approaches upon the states * * * no sanctions should be imposed on a state by virtue of not undertaking LCCA in the form set forth by FHWA.''

One industry organization and approximately half the States commenting on the interim LCCA policy statement cautioned that an LCCA should be only one factor in the decisionmaking process. For instance, the North Dakota Department of Transportation pointed out that an ``[e]conomic analysis of alternatives has long been a tool for the administrator and engineer to use in project level decisions. However, it is an inexact science. The process is rife with assumptions on discount rates and future costs. Managers know that it is only one tool, among many, that can be used to narrow down alternatives to consider and decisions to make * * * . It shouldn't be given any greater consideration than other factors.'' The FHWA understands that whether or not a State uses formal LCCA or less-formal methods for deciding among investment alternatives, uncertainties about future costs and performance remain and must be factored into the decisionmaking process. To ignore them is worse than to acknowledge the uncertainties and attempt to understand their influence on long term costs.

Suggestions were made that LCCA implementation should be phased in, to provide sufficient time for technical assistance in estimating user costs, discount rates, maintenance costs, etc. States with adequate cost and performance data could apply the technique and show other States how it can be used in the decisionmaking processes.

Several comments suggested that LCCA may be appropriate for project level decisions, but that it is not suited for network level decisions.

Some suggested that other types of economic analysis such as multi-objective programming and benefit-cost analysis may be more appropriate for some decisions. When discussing other economic analysis techniques, these comments generally failed to recognize that each of these economic analysis methods usually requires consideration of future benefits and costs, which is at the heart of an LCCA.

A number of comments recommended clarifying the relationship between the design life and the analysis period in the final policy statement. Definitions of these two terms vary slightly from reference to reference, but design life is generally understood to reflect the expected service life of an improvement. The analysis period for an LCCA generally should extend through the time when reconstruction of the facility would be required. Relatively long analysis periods help to assure that life cycle costs for the full range of reasonable investment alternatives, including eventual reconstruction of the facility, are considered.

Several comments expressed the concern that the analysis periods discussed in the interim LCCA policy statement were too long. For instance, one State questioned whether 30 years was too long for a simple overlay project, and a construction firm commented that a design life of 75 years was too long for most hydraulic structures and could result in the construction of obsolete facilities. The interim policy statement suggested these periods as minimum analysis periods, not minimum design lives. As noted above, the analysis period is generally longer than the design life of an improvement and should extend through the time when facility reconstruction would be required. Thus for pavements, the analysis period may extend through several overlay and rehabilitation cycles and include reconstruction as one investment alternative, depending on the age and condition of the facility.

Several comments discussed the use of discount rates in LCCA. Some supported relying on Office of Management and Budget OMB Circular A-94 as the basis for setting discount rates, but one comment indicated that Circular A-94 is ambiguous about how to select the appropriate discount rates. One comment recommended that FHWA's LCCA policy be more prescriptive on the discount rate to be used and that explicit procedures for determining the discount rate be part of the LCCA policy rather than simply referencing OMB Circular A-94. Another comment suggested that definitive guidance should be given to determine the appropriate discount rate similar to guidance included in the interim policy statement on analysis periods for different types of improvements. One comment suggested that regional discount rates be developed to reflect differences in regional economic conditions. Yet another comment said that too much emphasis has been placed on the discount rate and that many other uncertainties are more important.

The inclusion of user costs in an LCCA generated many comments, the most frequent of which were the difficulty in estimating user costs, the need for technical assistance in this area, and suggestions that user costs not be required in an LCCA until technical advisories are available. A few comments raised concerns that user costs could overwhelm other costs in the analysis. Several recommended that user costs be excluded from LCCAs because of the difficulty of estimating user costs and the fear that including user costs would favor urban projects over rural projects. Regarding this latter point, inclusion of user costs in benefit-cost or other types of economic analysis used in developing annual or multiyear transportation improvement programs could favor urban projects, but at the project level, including user costs in an LCCA would only affect project design and related decisions, not where the projects are located. The FHWA believes that since user cost savings are the single most important benefit in justification of most highway improvements, then, it follows, that user costs should be included in any LCCA.

There were many comments concerning the need for technical assistance, not only in the selection of discount rates and the estimation of user costs, but also in estimating the service life of improvements and future maintenance and rehabilitation costs. The FHWA has included an LCCA module in its course on value engineering, and is developing additional training and technical advisories that should be available.

Since the interim LCCA policy statement was published in July 1994 and comments submitted to the docket, several legislative and programmatic changes have occurred that affect LCCA requirements. On November 28, 1995, the NHS Designation Act of 1995 (Pub. L. 104-59, 109 Stat. 568 (1995)) was enacted. Section 303 of that Act entitled, ``Quality Improvement,'' modified section 106 of title 23, United States Code (U.S.C.), by adding a new subsection (e) entitled ``Life-Cycle Cost Analysis.'' Subsection 106(e)(1) of title 23, U.S.C. now directs the Secretary to establish a program that requires States to conduct an LCCA for each NHS project having a usable project segment costing $25,000,000 or more. This subsection further defines LCCA as ``a process for evaluating the total economic worth of a usable project segment by analyzing initial costs and discounted future cost, such as maintenance, reconstruction, rehabilitation, restoring, and resurfacing costs, over the life of the project segment.''

Both the House and Conference Committee reports on the Act indicate that the basic intent of requiring an LCCA on higher-cost Federal-aid NHS projects is to, ``reduce long-term costs and improve quality and performance.'' Although the House Committee report language indicates a desire for the Secretary to specify uniform analysis periods and to promote uniform use of discount rates as established by the OMB Circular A-94 , the Conference Committee report language suggests that the Secretary should not prescribe the forms of life cycle cost analysis that a State must undertake. Further, the Conference Committee report states that the intent of section 303 is to limit the Secretary's ability to require life-cycle cost analysis to high cost NHS usable project segments.

The NHS Act did not rescind life-cycle cost requirements established by the Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA) (Pub. L. 102-240, 105 Stat. 1958, 1964) and found in 23 U.S.C. Sec. 134(f)(12) and Sec. 135(c)(20). These sections specifically require consideration of ``the use of life-cycle costs in the design and engineering of bridges, tunnels, or pavement.'' The potential benefits of conducting LCCA in support of decisions on significant highway investments that fall below the $25 million threshold established by the NHS Act could be significant.

The FHWA has issued guidance advising its field offices to encourage States, at the highest levels, to consider life cycle costs in making major investment decisions. This guidance suggests several sources of technical information on performing an LCCA, and indicates additional LCCA work that is underway including a National Cooperative Highway Research Program (NCHRP) Project entitled Life-Cycle Cost Analysis of Bridges which will be available in 1998, technical guidelines for the application of LCCA to pavement design, and a demonstration project on the use of probabilistic life-cycle cost analysis in pavement design that will be available in early 1997. Section 205 of the NHS Act, ``Relief From Mandates,'' suspended the

requirement that States implement the pavement, bridge, and other management systems established by ISTEA and stipulated that ``[a] State may elect, at any time, not to implement, in whole or in part, 1 or more of the management systems.'' Section 205 also states that ``[t]he Secretary may not impose any sanction on, or withhold any benefit from, a State on the basis of such an election.'' With implementation of pavement and bridge management systems rendered optional, use of LCCA in connection with those systems will be at the State's election, except for those projects on the NHS costing $25,000,000 or more.

Provisions of the NHS Act pertaining to LCCA generally are consistent with the majority of comments received on FHWA's interim LCCA policy. The Act and accompanying Committee report language recognize the importance of conducting LCCAs for the highest cost NHS projects. The $25 million threshold at which LCCA becomes mandatory for Federal-aid funding is higher than thresholds suggested in docket comments which ranged from $1 million to $10 million, but States will be encouraged to consider life cycle costs for other high cost NHS projects that do not meet this threshold. Language in the Conference Committee report stipulating that no particular form of LCCA is to be prescribed also is consistent with most of the docket comments and with the intent of the interim policy statement as well. Principles enunciated in the interim policy statement were intended to reflect good practice. These principles recognize that flexibility in approach may be necessary to account for unique project characteristics. Guidance issued to FHWA field offices following passage of the NHS Act states that ``[t]he FHWA Division Offices should not prescribe the forms of LCCA that a State undertakes. The division offices should, however, assure that LCCA are consistent with the established fundamental principles of good/best practice * * * [T]o reflect good/best practice, an LCCA should have sufficiently long analysis periods to reflect long term cost differences associated with reasonable investment alternatives, employ accepted discount rates, and address the inherent variability in input parameters.''

Because of the large potential benefits of LCCA, which were recognized in comments to the docket and in Committee reports on the LCCA provisions of the NHS Act, the FHWA continues to develop technical guidance on the application of LCCA to pavements, bridges, and other types of highway improvements. An overall reference document on LCCA, along with examples of the application of LCCA for different types of improvements, is being developed and will be available by the end of 1996. As noted above, guidelines and a demonstration project on the application of LCCA to pavement design are being developed and an NCHRP project on the application of LCCA to bridges is underway as well. As additional training and technical assistance needs are recognized, the FHWA will fill them.

This policy statement sets forth principles of good practice for the application of life-cycle cost analysis to highway and related infrastructure investment decisions. The FHWA fully supports and promotes sound economic analyses of highway investment alternatives that consider relevant costs and benefits over the full life of the facility. States and local agencies are encouraged to follow these principles in evaluating highway investment alternatives. Alternative forms of LCCA are acceptable if they are consistent with principles of good practice contained in this statement.

1. Life-cycle costs are important considerations along with budgetary, environmental, safety, and other factors in highway investment decisions. Investment alternatives having the least net cost (or the greatest net benefit) cannot be identified without considering streams of discounted benefits and costs over the entire life of the investment. Especially in periods of tight budgets, it is important to use life cycle cost analysis, value engineering, and other appropriate techniques to maximize the return from investments of scarce highway resources. The importance of considering life cycle costs in infrastructure investment decisions was emphasized in the President's Executive Order 12893, ``Principles for Federal Infrastructure Investments.''

2. Life-cycle cost analysis principles involving the systematic evaluation of costs and benefits over the life of highway improvements have been utilized in benefit-cost analysis, cost-effectiveness analysis, and other economic analysis techniques for many years. Continued use of these principles can help reduce costs of providing essential highway services that stimulate our economy and enhance our quality of life.

3. Life cycle costs should be considered in all phases of construction, maintenance, and operation. A project's design will affect its initial construction cost as well as future maintenance and rehabilitation costs. The initial design can affect not only the frequency of required maintenance, but costs of performing maintenance as well. Whether as the result of formal value engineering studies or less formal evaluation of design alternatives, small changes in design that facilitate maintenance and operations may pay for themselves in long-term cost savings.

4. Analysis periods used in LCCAs should be long enough to capture long-term differences in discounted life-cycle costs among competing alternatives and rehabilitation strategies. The analysis periods should cover several maintenance and rehabilitation cycles and, depending on the condition and age of the facility, may cover reconstruction of the facility as well. Analysis periods for improvements on Interstate and other NHS highways generally should be longer than for improvements on lower order roads, reflecting the NHS's greater importance.

5. All significant differences in agency and user costs anticipated during the analysis period should be considered in the analysis. Agency costs should consist of initial construction costs, future maintenance and rehabilitation costs including traffic control costs and costs of special construction procedures to maintain traffic, and agency operating costs for such things as tunnel lighting and ventilation. Where the agency operating a facility is not the one making the investment decision, it is important for the funding agency to include operating costs borne by all organizations responsible for operating the facilities. User costs to be considered in an LCCA generally include vehicle operating costs, accident costs, and delay-related costs incurred throughout the analysis period. Increased costs due to deteriorated riding surfaces, circuitous routings, and accidents and delays around and through work zones are important cost considerations.

6. While there may be considerable uncertainty about the life of an improvement, future traffic using the facility, future maintenance and rehabilitation costs, user operating and delay costs, the appropriate discount rate to use, and other elements of LCCA, these factors should all be considered in the analysis. Regarding uncertainty, Executive Order 12893 indicates that ``[w]hen the amount and timing of important benefits and costs are uncertain, analyses shall recognize the uncertainty and address it through appropriate quantitative and qualitative assessments.'' These assessments may include sensitivity analysis, probabilistic or risk analysis techniques, expert panels, or other methods for estimating the degree of uncertainty underlying key LCCA factors and the influence of that uncertainty on the choice of investment alternatives. Even if there is a relatively high degree of uncertainty about key LCCA factors, it is better to try to evaluate that uncertainty than to ignore it.

7. Future agency and user costs should be discounted to net present value or converted to equivalent uniform annual costs using appropriate discount rates. Discount rates selected should be consistent with guidance provided in OMB Circular A-94.

Technical advisories on these and other technical issues in the application of LCCA will be issued by FHWA in the future.

Authority: 23 U.S.C. 315; Pub. L. 102-240, sections 1024 and 1025 (December 18, 1991); Pub. L. 104-59, section 303 (November 28, 1995); 49 C.F.R. 1.48.