The environmental impact of energy production and use is well documented. Residential energy use is a major component of total energy use. Much of the energy used in houses can now be cost-effectively saved by constructing them more efficiently or by retrofitting existing houses with more efficient equipment. Unfortunately, many of the opportunities to save energy and money in houses are not captured. There are a number of well documented market failures that explain this phenomena including lack of information and bias towards up-front capital costs rather than life-cycle costs. The net loss to society from these missed opportunities in terms of wasted money and wasted natural resources is huge (NASEO 1996).

Since the 1970's energy efficiency proponents have developed a number of regulatory policies (e.g. Demand Side Management; building codes) and voluntary programs that have addressed these market barriers. However, regulatory mechanisms are increasingly endangered in the current atmosphere of deregulation and therefore there is a greater need for voluntary, market-based mechanisms. One such mechanism is Home Energy Rating Systems and the associated energy-efficiency financing products.

A Home Energy Rating System (HERS) is a system for collecting and processing the data needed to produce a home energy rating, which is a standard measurement of a home's energy efficiency and its potential for improvement.

1. Input Data

The first step in a HERS rating is for a certified rater to collect the necessary data on the house to be rated. Usually a site visit is required but it is possible to rate a house based on the engineering drawings. The required pieces of information vary depending on the particular HERS but generally include the following:

• utility providers and rate schedules
• house age, location (climate zone), and orientation (front azimuth)
• house dimensions (e.g. wall lengths and heights, overhang sizes, etc.)
• thermal envelope composition characteristics (e.g., wall, window, roof, and basement types, insulation levels, window shades, etc.)
• size, efficiency, age, and fuel type of heating system, permanent air conditioning system, and water heater
• inventory of lamp type and wattages in permanent lighting fixtures
• existence and fuel type of other appliances (clothes dryer, cooking range, pool, hot tub, etc.)

Often it is not possible for a rater to gather certain pieces of information so he/she must make assumptions either based on a formula or based on experience. For example, in older houses the furnace size and efficiency is often not clearly marked on the furnace. The rater may make an educated guess or consult a default table that lists average values based on house age.

a) Diagnostics

Rather than use standard assumptions for certain house parameters, it is sometimes possible to use testing equipment to empirically determine parameter values. For example, the accuracy of a rating can be improved by conducting air leakage tests of a house's envelope and it's duct system using blower door testing equipment. Diagnostic testing equipment can also be used to ascertain the efficiency of a furnace. Diagnostic testing can improve the accuracy of ratings but it increases the cost of ratings by increasing the amount of time and equipment required to conduct a rating.

2. Simulation Tool

Input data are fed into a computer program. There are hundreds of different software programs for simulating building energy use. Programs have been developed for many types of buildings (commercial, residential, etc.) and for many different uses (building design, HVAC equipment sizing, code compliance, etc.). HERS software is a small subset of this universe of building software. Most HERS simulation tools build a model of the house and simulate energy use for one year using standard assumptions for the required information that is not gathered by the rater. Assumptions are always made for the following:

• typical weather for that climate zone (based on climate records)
• standard occupant behavior (thermostat setpoints, hot water usage, personal appliance usage, etc.)

Even if actual weather data are available for a particular year or if occupant data are available, this information cannot be incorporated into the simulation because HERS are designed to rate the house irrespective of any particular occupants or the weather in a particular year. Most HERS also model and simulate a "reference" house that has the same dimensions, orientation, basement type, and fuel type as the rated house but is constructed to a particular building code such as CABO MEC (Council of American Building Officials Model Energy Code) or California's Title 24 (an energy code for new construction in California).

3. Output

The HERS software produces three types of output:

a) Rating Score

A score is a measure of a house's efficiency relative to its reference house. Scoring is usually on a zero-to-100-point scale or a zero-to-five-star scale (the higher the score, the more efficient the house). Scores are usually computed for a house's overall energy use and for several end-uses including heating, cooling, and water heating. Typically, if a house receives a score of about 80, then it is performing as well as if it were built to the building code of the reference house. However, different houses can be built to code and have very different energy use on a whole house or square foot basis due to differences in shape, orientation, basement type, shading, etc. Therefore, unlike a mile-per-gallon rating or an appliance Energy Guide Label, a HERS score is technically not designed for comparison between houses.

There is currently considerable controversy within the HERS community over how to weight different fuels in the scoring process. Some people argue that a BTU is a BTU and they should all be weighted equally, regardless of the source (this is referred to as "site energy" scoring). Others point out that a BTU of electricity usually costs more than three times as much as a BTU from natural gas. They prefer a "source energy" scoring system that includes the efficiency of the power plant and distribution losses in the utility wires, thereby more closely reflecting the true cost to the consumer.

b) Energy and Cost Estimate

A HERS gives an estimate of annual energy use and energy cost for a house as it currently exists, assuming typical occupant behavior. Estimates are also broken down into end-uses. End-use estimates are more important than overall estimates because they are more dependent on the permanent features of the house which HERS are designed to characterize and improve. Overall estimates include end-use estimates but are also largely determined by the "other" end-uses like cooking, refrigeration, and electronics, which HERS are not designed to measure. Thus standard assumptions are made for all "other" energy uses based on house size. Unlike the rating score, the energy use and energy cost estimates are designed to be used to compare different houses. The Score and Estimation portion of a HERS for a particular house might look as follows:

c) Recommendations

A HERS will recommend energy efficiency improvements that are cost-effective on a life-cycle basis for a particular house. There are different methods for estimating cost effectiveness. According to a common method a measure is cost effective if its annual energy cost savings are greater than the annual cost of the item if the incremental capital cost is financed over the lifetime of the item at a certain interest rate. Incremental capital cost implies that for each recommendation to replace a piece of equipment, that equipment is already in need of replacement. The incremental cost, for example, is the difference between (a) the cost of replacing an old furnace with a new one of the same efficiency and (b) the cost of replacing the old furnace with a higher efficiency furnace.

The Recommendations section of a HERS usually shows the estimated incremental installation cost of each item and one or more economic measurements of cost-effectiveness such as internal rate of return or simple payback period. The Recommendations section of a HERS might look as follows:

There are dozens of private and state and local governmental organizations that provide HERS. A common type of HERS provider is a private non-profit organization that may be a member of a national HERS organization. Private HERS providers often receive funding support from utilities and government agencies. Most HERS, however, are expected to eventually become financially self-supporting based on fees for processing ratings and other services. Raters are typically not employed by the HERS provider but rather they are usually independent energy consultants, mechanical contractors, etc. Raters charge customers for ratings (ratings are often subsidized or financed) and pay a fee to the HERS provider for processing the ratings and for training and certification. Most HERS providers buy or lease their HERS software from one of two private software firms. Many providers have developed their own software. It is common for HERS providers to switch to a different software provider or update to a newer software version as new and better products come onto the market.

1. Information

The simplest use of a HERS rating is to provide information to homebuyers and others. In the same way that a car shopper may want to know a car's fuel-economy rating, a HERS rating provides a homebuyer with valuable information on a home's estimated energy use and potential for improvement. Many people believe that the availability of HERS information will increase the value of a house and encourage home builders and owners to improve energy efficiency.

2. Labeling/Certification

A number of labeling and certification programs have been developed that rely on a HERS to demonstrate that a particular home qualifies for that particular label. Often the label has name recognition in the marketplace and a house with the label could therefore be worth more than a similar house without the label. The label or certificate can also qualify the owner or builder for other incentives, including publicity that can help market a house. For example, a home in Colorado can qualify for the E-Star Certificate if it receives 4 or more stars on a HERS rating conducted by an Energy Rated Homes of Colorado certified home energy rater (RESNET Notes, 9/26/96). Curiously, most labeling programs rely on the overall score to qualify a house, rather than estimated energy costs, even though scores are not designed to be used to compare different houses.

3. New Construction Incentives

Many utilities and state and local government agencies offer various financial incentives to home builders who meet certain efficiency standards (Vine 1995). The State of Michigan, for example, recently awarded grants to five builders who will build five star energy rated homes (RESNET Notes, 2/27/97). Communities in the Chicago area that are experiencing explosive growth are considering using HERS ratings and a modified permit fee schedule to allow rebates of high rated efficiency homes (RESNET Notes, 8/16/96).

4. Energy Efficiency Financing

There are at least two types of Energy Mortgages (EMs).

a) Energy Efficient Mortgages

An Energy Efficient Mortgage (EEM) allows the buyer of a highly efficient house to qualify with a lower income. One type of EEM is a "two percent stretch" of the debt to income qualifying ratio. Typically a homeowner's monthly PITI payment (principal, interest, taxes, and insurance) cannot exceed 28% of his/her monthly income. However, if the house meets a certain threshold on the HERS scoring system, then the homeowner's PITI payment can be as much as 30% of his/her monthly income. The rationale is that the homeowner will be paying less for energy and will have more money left for mortgage payments.

b) Energy Improvement Mortgages

An Energy Improvement Mortgage (EIM) allows a homebuyer to incorporate the cost of cost-effective energy retrofits into a home loan. For example, if a HERS rating recommended $5,000 of cost-effective energy retrofits, then the lender can add this amount to a normal mortgage, making it an Energy Improvement Mortgage. Again, the rationale is that monthly energy savings will be larger than the increase in monthly mortgage payments.

Local mortgage banks in many parts of the country have been able to offer EEMs and EIMs because government or quasi-governmental agencies in the national secondary mortgage market purchase, guarantee, or insure EIMs and EEMs. The Veterans Administration (VA) and Federal Housing Administration (FHA) provide loan insurance or guarantees to primary market lenders who offer EMs that meet certain criteria. Fannie Mae and Freddie Mac offer to purchase EMs that meet their criteria. Now private banks that purchase "jumbo" mortgages on the secondary market are also beginning to offer EMs. (Jumbos are large mortgages that exceed the mortgage size limits of the governmental and quasi-governmental players.)

c) Home Improvement Loans

Utilities often form partnerships with local lenders to finance cost-effective home improvements, such as adding insulation or replacing heating equipment. These are unsecured loans, often at below-market rates, and can range from $1,000 to $25,000. Loan payments can even be included on a customer's utility bill.

HERS and HERS-related financing products have only captured a tiny fraction of the potential market. In order to increase the penetration rate, HERS need to address a number of challenges and questions. One such question is: Do they work? More specifically, will a house really use less energy than another house if it has a higher HERS score? Will a house really cost as much to operate as the rating says? And will recommended improvements really be cost effective? Clearly a rating will not always yield the exact right answer to these questions, but how close will the rating come to the answer? Buyers, lenders, builders and others who make investments based on HERS output need to know what degree of risk they are being exposed to and what the chances are that the rating is steering them in the wrong direction. Validation data are needed for at least two reasons: (1) to demonstrate to consumers, funding agencies and others that HERS are technically sound, and (2) to gather data necessary to improve the accuracy of HERS.

Unfortunately, almost no information to address the question of HERS accuracy has been made publicly available. Recognizing the need (for data) to evaluate and improve rating tool accuracy, the HERS Council Guidelines call for all HERS providers to maintain a database of HERS input and output data, utility bill releases and information on retrofits for at least 10% of homes rated annually, or 500 homes annually, which ever is less (HERS Council Guidelines Version 2.0)¹ .

In a report entitled "HERS Projected Energy Use versus Actual Utility Bill Analysis," the HERS Council concludes that:

• It is difficult to obtain meaningful data in order to connect predicted energy use with actual consumption determined from utility bills.
• Collecting validation data and developing appropriate data analysis procedures is important for improving HERS accuracy (HERS Council 12/1996).

The National Renewable Energy Laboratory, which has been involved in developing procedures for assessing HERS accuracy, also recognizes the need for "further development of empirical validation methods appropriate for testing HERS software" (NREL, 1995).

Thus the primary objectives of this research were:

• to collect HERS input and output data and utility bill data for homes that have been rated with HERS.
• to develop appropriate data analysis procedures for interpreting validation data in order to describe and improve HERS accuracy.
• to examine the role that accuracy plays in the future success of HERS and HERS-related energy efficiency financing programs.

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