By this decision, we adopt a transitional plan for additional flexibility permitting adjustments in retail rates for "basic telephone service"¹ effective beginning January 1, 2009. Pursuant to the Uniform Regulatory Framework (URF) adopted in Decision (D.) 06-08-030, current restrictions on the rates for residential basic service of the four major incumbent local exchange carriers (ILECs) in California² are due to expire effective January 1, 2009.

ILEC basic rates have remained fixed since the mid-1990s (except for one minor inflation adjustment in 2008 allowed by the Commission and the state Legislature through the Digital Infrastructure and Video Competitive Act (DIVCA). Prior to 2008, Verizon last increased its rate in 1995 (from a monthly rate of $9.75 to $17.25), Frontier last increased its rate in 1996 (from $16.40 to $17.85), SureWest last increased its rate in 1997 (from $16.85 to $18.90), and AT&T last increased its rate in 1995 (from $8.35 to $11.25, subsequently lowered to $10.69 in 1999). Monthly rates for AT&T customers in California are the lowest in the nation and more than $8 per month lower than the nationwide average.³

Today we also adopt as an interim California LifeLine Telephone Program (LifeLine) rate increase a basic service rate cap for the period beginning January 1, 2009 through December 31, 2010 of 25% of the rate cap increment that we authorize today. In doing so, and as necessary to comply with today's decision, we temporarily suspend General Order 153, Sec. 8.1.4, which otherwise limits LifeLine rate discounts to 50%.⁴ This authorization will expire upon issuance of a decision in our Universal Service proceeding (R.06-05-028), addressing how the LifeLine program will be changed to reflect the Basic Rate Decision adopted today.⁵

We direct parties in the Universal Service Docket (R.06-05-028) to file comments on October 1, 2008, to refresh the record, including considerations of affordability, avoiding rate shock, and the impact of the LifeLine subsidy on nonLifeLine customers; funding for needed increase in LifeLine subsidies; and any reforms to the LifeLine program structure such as changes in eligibility and/or services that are recommended in light of today's decision. We commit to adopt our decision on LifeLine reform in R.06-05-028, including the final LifeLine basic rates, with an effective date of January 1, 2009.

D.06-08-030 determined that the voice market in California is competitive and D.07-09-020 reaffirmed that finding and determined that after a transition period, prices should be based on competitive market forces.⁶ The plan adopted herein will allow for ILEC basic rates to transition to market-based pricing beginning January 1, 2009, through an orderly phased process that avoids rate shock while preserving affordability. The basic provisions are as follows:

1. AT&T, Verizon, SureWest, and Frontier (the ILECs) shall each be permitted, but not required, to increase their basic rates by prescribed amounts over a two-year phase-in period beginning January 1, 2009, as follows.

2. Each of the ILECs is permitted to increase its basic flat rate by up to $3.25 effective January 1, 2009 and by up to an additional $3.25 effective January 1, 2010. These increases capture the cumulative difference (between nominal and inflation-adjusted dollar value in the AT&T basic rate since AT&T's basic rate was frozen in 1995 through December 31, 2010), applied in equal installments over a two-year period.

3. In order to be consistent with the flat rate adjustments, each of the ILECs is also permitted, but not required, to increase basic rates for measured residential service by the same percentage as applies to the corresponding flat rate increase. The resulting percentage increases allowed for measured service rates are: (a) For AT&T - 30% for 2009 and 23% for 2010; (b) For Verizon- 18% for 2009 and 16% for 2010; for SureWest - 17% for 2009 and 15% for 2010; for Frontier - 18% for 2009 and 15% for 2010.

4. The authorization to increase the basic service rate cap means that the ILEC may elect to charge less than or equal to the capped amount, but may not charge more. The Commission is not requiring the ILEC to raise its basic rate but giving it permission to do so if it so desires to meet current market conditions. If an ILEC does increase basic rates pursuant to the additional flexibility granted in this decision, the ILEC must first file an advice letter and provide 30-day advance notice of the increase to affected customers pursuant to D.06-08-030 (Ordering Paragraph 9).

5. Effective beginning January 1, 2011, all four ILECs will acquire full pricing flexibility for stand-alone basic rates in regions where basic service is not subsidized by the California High-Cost Fund B (CHCF-B) (and excluding Lifeline).⁷

6. In areas where basic service continues to be supported by the B-Fund, any rate adjustments implemented by a Carrier of Last Resort (COLR) for stand-alone basic service after January 1, 2011, may not exceed (a) 150% of the highest rate for stand-alone basic service offered by that same COLR outside of the high-cost areas, or (b) the high-cost benchmark of $36 minus the EUCL, whichever is lower.⁸ This restriction will only apply to those carriers serving in high-cost regions where they are designated as a COLR. The restriction will not apply to any carriers in regions where they are not designated to receive B-Fund support as a COLR.

7. LifeLine rates for basic flat rate and measured service will be affected as previously explained above.

With the expiration of the remaining rate freeze on January 1, 2009, we are seeking to provide for an orderly transition of the basic rate to market-based pricing while preserving affordability in high-cost areas. Under the plan adopted herein, customers will experience more market-driven pricing of basic service. Given the level of competition in the marketplace, we believe the ILECs should be allowed to adjust the basic rate to meet their unregulated competition in a flexible manner. This transition plan is builds upon reforms initiated in Phase I of this proceeding, in which we reduced CHCF-B support by more than $300 million per year through the phase-in of a new $36 benchmark to calculate support amounts. At the same time, we retain appropriate safeguards to preserve the affordability of stand-alone basic service, particularly in "high-cost"

areas. If basic service becomes unaffordable to customers, we will fall short of our long-standing goal of universal telephone service.⁹

The transition process that we authorize herein continues the reform measures begun in URF and continued in Phase I of this Universal Service B Fund proceeding, which resulted in a major retargeting of B-Fund subsidies to "carriers of last resort" (COLRs). As determined in D.07-09-020, beginning on July 1, 2009, high-cost support will be limited to regions with a proxy cost above $36 per line. We also intend to further update the level of high-cost support by implementing a reverse auction process to ensure that affordable basic service remains available while minimizing the required subsidy. Protections for customers within designated high-cost areas similar to those that we adopt in this decision will be incorporated into the design of the reverse auction.

¹ "Basic Telephone Service" consists of the service elements offered to residential customers as prescribed in the tariff of each respective ILEC, and represents the minimum level of telecommunication services that must remain available ubiquitously, consistent with the universal service principles in D.96-10-066. In response to a request by parties, the Commission is concurrently evaluating how the "basic service" definition should be updated to recognize the wide array of technological choices available today.

² The URF ILECs are: Pacific Bell Telephone Company dba AT&T California (AT&T), Verizon California Inc. (Verizon), SureWest Telephone (SureWest), and Citizens Telecommunications Company of California Inc, dba Frontier Communications Company of California (Frontier). Any subsequent reference to ILECs, as used in this decision is intended to apply exclusively to the URF ILECs. Unless expressly indicated otherwise, references to ILECs are not intended to refer to any small independent local exchange carriers. Any subsequent references herein to "high-cost" areas pertain exclusively to the B-Fund program.

³ See FCC's 2007 Reference Book of Rates, Price Indices, and Household Expenditures for Telephone Service, Table 1.3 (rates from the Urban Rates Survey as of October 15, 2006).

⁴ Under Pub. Util. Code § 874, we are directed to establish LifeLine rates at "no [...]more than 50 percent of [the basic service rate]," and we rely upon that statutory authority in our action today.

⁵ The LifeLine Program, formerly known as the Universal Service LifeLine Telephone Service (ULTS) Program, was established by the Commission in compliance with Pub. Util. Code § 871 and provides discounted basic residential (landline) telephone services to eligible low income households.

⁶ See D.06-08-030 at 132, FOFs 77, 86, COLs 20, 28, D.07-09-020 OPs 7-8, 13, as modified by D.07-11-039. As noted above, the Commission has a LifeLine program that will address issues relating to affordability of telephone service by low-income residents.

⁷ Possible reform to the Lifeline program, including preserving affordability resulting from any effects from changes authorized in this decision, is before us in Rulemaking (R.) 06-05-028. We make no prejudgment in this proceeding as to how Lifeline will be reformed.

⁸ Rules for reverse auctions are currently being formulated as the means by which a COLR will be selected, regions where B-Fund support will be applied, and amount of B-Fund support will be determined. In the event that a carrier other than the ILEC should take over as COLR in a given high-cost area, then any rate restrictions on basic service rates prescribed by this Decision would apply thereafter to that new COLR. We institute this requirement as an interim measure for the period after January 1, 2011, to provide an additional level of protection, though we do not anticipate it will ever be invoked as additional changes to the CHCF-B methodology will supersede this requirement.

⁹ Policies enacted by the Legislature and the Commission have enabled California to consistently have one of the highest telephone penetration rates in the nation for the past 20 years. (See CPUC Universal Service Telephone Report to the California Legislature at 4-5, 16, May 2008.) Thus, even though the real inflation-adjusted price of basic telephone service has fallen between 1995 and 2007, price has had little effect on penetration rates for basic service. See also Study on Affordability of Basic Telephone Service, 2004, Field Research Corporation, Volume 1 at 2.3a and 5.2a and Volume 2 at 4.7 (both mean and median total cost per month of respondents were significantly higher than actual monthly cost, and higher than new high cost benchmark).