Price Caps Still Dominate Retail Phone Rate Regulation

Rate of return regulation applies to the dominant incumbents in Alaska, Ariz., Hawaii, Mont., N.H., and Wash. The ROR regimes allow varying degrees of pricing flexibility for services subject to competition, but revenue from flexibly-priced competitive services continues to count in rate-of-return calculations.

At the opposite extreme are Ida., Neb., S.D. and Wyo., which have removed much or all retail rate regulation from their books. Ida. has largely deregulated Qwest. It imposes rate regulation only on basic exchange service to accounts with fewer than 5 lines. Ida. permits basic-exchange rate deregulation in exchanges with effective competition. After the PUC denied a deregulation bid in 2003, Qwest failed in a bid to win deregulation in the 2004 legislature. S.D. and Wyo. in 2003 ended the last of their retail telephone rate regulation. Neb. ended its retail telephone rate regulation in 1986, but retains a rollback provision for unjustified extreme rate increases.

In N.Y., Verizon has been operating under a unique tariff regulation system since March. Under this system, Verizon can change rates for basic services by tariff, but only if it can cost-justify the change. Nonbasic and competitive services are flexibly priced. Earnings can be reviewed by the PSC if excessive profits are suspected, but it’s not really rate-of-return regulation. Other incumbents in N.Y. are either price capped or under rate- of-return. In W.Va., Verizon and mid-sized incumbents operate under a unique flexible pricing system where earnings regulation is suspended, but not eliminated.

Regulation of mid-sized incumbents goes all over the map from rate-of-return to deregulation. Mid-sized incumbents are under ROR in 29 states. One or more mid- sized telcos are price capped in Ala., Cal. Fla., Ga., Ind., Ia., La. Nev., N.M., N.Y., N.C., Pa., S.C., S.D., Va. and Wis. They are rate deregulated in Neb., S.D., and Wyo. and under unique alternative systems in Mich. and W.Va.

The smallest incumbents, generally those with fewer than 50,000 lines, operate under rate-of-return in 38 states, but most of these states give them the option to seek alternative regulation. Small incumbents are regulated by price caps in Ala., Ark,, Fla., La., Pa., and Tex. Small incumbents’ rates are deregulated in Ia., Neb., N.M., Ore. Va. and Wyo. Ind., Mich. and Wis. have unique mixes of price and earnings regulation for their small incumbents.

CLECs generally operate with minimal regulation, but all states require CLECs to obtain a state certificate, license or other operating authority. Only a handful of states exert control over CLEC rates. In Del., CLECs can’t price below cost floors. In N.J., CLEC rates for basic exchange, vertical services and access charges are capped at Verizon’s rates. And in Va. and Mich., CLEC rates are capped at the incumbent’s level. Ohio requires regulatory approval for CLEC rate changes outside established floor and ceiling levels. In Ill., and Neb., CLECs that receive state universal service subsidies are subject to the funds’ rate benchmarks.

Ariz. represents a unique case for CLECs. The utility regulation code is embodied in the state constitution and requires earnings-based regulation of all public utilities. CLECs are no exception. But a 2001 state Supreme Court ruling spared regulators’ holding endless CLEC rate cases. The ruling gave regulators broad discretion to interpret the relationship between CLECs’ rate base and their rates: Regulators can look at the earnings implications of individual rate changes without having to conduct a general earnings review.

Eight states and D.C. are looking at changes to their telephone regulation programs. Verizon has proposed new regulatory plans in Vt., Va. and D.C., and modifications to current plans in Md. and W.Va. BellSouth has proposed a new cap plan for N.C. Qwest in Colo. has proposed to largely deregulate retail rates rather than continue with price caps. And Ala. and Ia. are conducting general reviews of their telephone rate regulation programs with changes possible next year.

In Vt., the Public Service Board (PSB) plans hearings in mid Sept. and another session in mid-Oct. to consider a successor to Verizon’s price cap regulation plan, which is to expire next April. The PSB staff had urged the agency to start early on a successor plan to determine how well the current plan has worked, whether other forms of price- based regulation would be appropriate, or whether Verizon should be returned to rate-of-return regulation. Verizon has proposed a successor plan that would continue price caps for basic residential services with flexible pricing for everything else. The current Verizon plan, adopted in 2000, put all services under non-indexed price caps pegged to April 2000 rate levels -- with a series of mandated rate cuts over the life of the plan, to compensate for overearnings while Verizon was under rate-of-return regulation before this plan’s adoption. The schedule in Case 6959 calls for completion of discovery in Dec. and final briefs by late Jan., with a ruling by March 22. Any new plan adopted would take effect April 22.

In Va., the Corporation Commission is considering a Verizon proposal for a new regulatory plan to replace the current price cap system for it and its Verizon South affiliate. Verizon said its proposal (Case PUC-2004- 00092) was filed in response to a 2004 state law (HB-938) that prohibits below-cost pricing of any telecom service. Verizon proposed to allow rate changes up to 10% annually until all services’ rates are brought to cost, with future rate changes occurring annually as costs change. Many services, especially in rural areas, could see substantial rate increases over time. Verizon wants the new system to be effective Oct. 1.

Verizon also is in the midst of a case in D.C. on a replacement for its price cap program, with a decision due by Nov. In D.C., Verizon proposed to extend the current plan through 2006, but with a 32 cents monthly local rate increase in 2006. It also has proposed some reclassification of services among the basic, discretionary and competitive baskets.

In W.Va., Verizon is seeking to add new services to the list of deregulated competitive services. An administrative law judge for the PSC recommended approval of a stipulated settlement worked out between Verizon and the PSC Consumer Affairs Div. Under that agreement, the PSC would add to the list of deregulated competitive services digital data services, primary rate ISDN service, frame relay and asynchronous transfer mode services, transparent LAN services and speed dialing service. The consumer div. also agreed not to press the PSC for review of Verizon’s competitive services every 2 years. In return, Verizon agreed to drop its plea for deregulation of local directory assistance and its channel services, Series 100 through 1,000.

In Md., the PSC is considering how to apply the Verizon cap plan’s inflation indexing formula to the carrier’s results for 2002 and 2003. The adjustment for 2000 and 2001 produced slight cap increases. But with the very low inflation of 2002 and 2003, cuts may be possible. In the docket, Verizon has proposed changes to the cap plan that would put many more of its services into the rate-deregulated competitive category.

In N.C., BellSouth has proposed major revisions to the price cap regulation plan in place since 1996. The plan features several “baskets” of services with different degrees of pricing flexibility based on how much competition BellSouth faces. BellSouth in Feb. proposed a radical restructuring of its price caps, putting basic residential service under indexed price caps and deregulating rates for all other retail residential and business services. BellSouth said its filing (Case P-55, sub 1013) would allow more pricing flexibility to reflect today’s restructured and more competitive telecom industry. BellSouth said it would cap basic residential service while allowing broad pricing flexibility for its other residential, business and “interconnection services.” The N.C. Utilities Commission set a Sept. 15 deadline for intervenor testimony. It also plans 5 public hearings around the state during Oct., with evidentiary hearings to start Nov. 29.

Verizon in N.C., operating under a multi-basket cap system similar to BellSouth’s, filed in June its proposal for a simplified cap system. Verizon (Case P-19, sub 277) proposed limiting rate increases for basic residential and single-line business services to 7% per year in exchanges where competition was weak or nonexistent, but would deregulate those rates in exchanges with effective competition. Rates for all other retail services would be deregulated throughout its territory.

Qwest in July proposed a new Colo. regulation plan to replace a price cap system that’s due to expire this year, but withdrew it a month later. Qwest proposed rate deregulation of all retail services other than residential basic exchange, which is capped at $14.74 monthly by state law, and certain public-interest services like 911. Qwest this month withdrew its application rather than spend $700,000 on a special mailing giving notice of the proposal to all its customers. Qwest plans to refile its petition in Oct., so the required customer notice can be sent out as a bill insert in the regular monthly billing cycle for about $30,000.

The Ala. PSC is considering a proposal to implement separate price capping systems for incumbent telcos, based on whether they're subject to competition. The PSC has one price cap system for all incumbents, but it opened a comprehensive global review of the regulation plans for all regulated telecom providers (Case 28950). The first workshop sessions began last week.

For BellSouth and other incumbents subject to competition, the proposal would cap basic residential and business service rates at present levels the first 2 years, and then allow rate changes up to 5% starting in year 4 and every 2 years after, up to statewide rate caps of $18 residential and $40 business. BellSouth alone would be allowed rate changes during years 3 and 4 to consolidate the current 6 rate groups into one, with a maximum residential rate of $16.30 and maximum business rate of $36.23. In year 4 and after, its caps would be the same as the other incumbents’.

Rates for vertical services could rise 5% per year, but couldn’t exceed the highest BellSouth rate prevailing in any of the 9 BellSouth home states. Rates for Lifeline, local directory assistance, 911 and any other N11 abbreviated dialing service would be frozen unless a telco could cost-justify a rate change. Rates for all other services could increase up to 15% per year in fully competitive markets, up to 10% per year in semicompetitive markets and by 5% per year in other market areas. Markets would be classified at the plan’s start. Telcos once a year could propose moving market areas from one competitive classification to another. No rate increases would be allowed in any exchange that doesn’t meet service quality standards. Below-cost rates would be prohibited unless a telco can show it is matching a competitor’s rate.

For rural incumbent telcos that have exemptions from competition obligations, the plan calls for an alternate price cap system that would cap all retail services at existing rates the first 3 years. After that, basic local rates could increase 1% per year, up to statewide caps of $18 for residential and $40 for business service. Rates for all other services could increase up to 2% per year. Here too, Rates for Lifeline, 911 and any other N11 abbreviated dialing service, and local directory assistance would be frozen unless telco can cost-justify a rate change, and no rate increases would be allowed in exchanges that don’t meet service quality standards.

The Ia. Utilities Board has completed initial briefings in its docket to determine which markets are competitive enough for full retail rate deregulation. The docket (Case INV-04-1) was opened in May in response to an unsuccessful Qwest effort to win statewide retail rate deregulation through legislation. At one point, the legislature considered a bill requiring a study of competition in the state, but that measure was dropped after the IUB said it would conduct the study voluntarily. --Herb Kirchhoff

(Editor’s Note: Details are available in 3 white papers. For copies, contact dwarren@warren-news.com)