2. Procedural and Historical Background

This decision implements provisions of Phase II of this proceeding concerning how basic rates may be adjusted subsequent to January 1, 2009. As a framework for implementation, it is useful to review how the Commission's pricing policies have evolved to ensure affordable basic service within the changing dynamics of technology and competition within the industry.

In the late 1980s, we replaced the long-standing practice of reliance on cost-of-service studies for ILEC rate setting, and instead implemented a more modern price cap index mechanism, in recognition of the increasingly important role of competition in the telecommunications industry. This "New Regulatory Framework" (NRF), was adopted for the two largest ILECs,10 and was subsequently authorized for the two mid-sized ILECs.11

Under NRF, ILEC services were accorded differing categories of pricing flexibility based on the competitiveness of the underlying services. "Basic monopoly services," including basic exchange service, were the accorded the most restrictive pricing. "Partially competitive" services were less restrictive, with rates capped subject to downward flexibility. Pricing of "competitive" services was accorded the maximum flexibility allowed by law.

In 1995, we effectively froze ILEC basic service rates12 at a level set to recover one-half of the ILEC's costs, and all other rate elements to recover the remaining costs of service. In this manner, we provided assurance that basic service remained affordable, at least for that year, 1995. Basic service rates remained frozen as we implemented the B-Fund program in 1996, pursuant to Pub. Util. Code § 739.3, as part of our framework to promote universal service as local exchange markets opened to competition.

Prior to the B-Fund, basic telephone service costs had been cross-subsidized implicitly through higher rates for other services.13 In D.96-10-066, the B-Fund created an explicit subsidy, and eliminated the implicit cross subsidies by reducing rates for many non-basic services that had been priced above cost.14 By replacing implicit pricing cross-subsidies with an explicit subsidy, the CHCF-B facilitated competitive market-based pricing for other services, while supporting the affordability of basic service. Over the following decade, we continued to impose price caps under the provisions of the NRF program.

Basic rates have remained frozen since then with the limited exception of inflation-adjusted increases of 2.36% authorized in D.07-09-020 for AT&T and Verizon rate caps, effective January 1, 2008. These increases were permitted under Pub. Util. Code § 5040 which codifies provisions of the 2006 Digital Infrastructure and Video Competition Act (DIVCA).15 AT&T and Verizon may charge less than the capped rate, but not more.

The table below summarizes the tariff flat rate for basic residential service that was in effect for each ILEC as of December 31, 2007, as well as the adjustments for 2008 that were authorized for AT&T and Verizon:

Basic Flat Rate Cap

Transitioning to market-based pricing for basic service is the next step in implementing the major pricing reforms that were extended in D.06-08-030 (the URF proceeding). In that decision, we removed rate cap and geographic averaging requirements for all services (except stand-alone basic and LifeLine service) in recognition of the growing influence of competition as a constraint on ILEC market power. As stated in D.06-08-030:

"the ubiquity of the FCC unbundling policies limits the market power of AT&T, Verizon, SureWest, and Frontier. Cross-platform competition, particularly that from wireless and VoIP technologies, provides an additional check that reduces market power of each carrier. Also Verizon and SureWest have demonstrated the presence of competitors throughout their entire service territories. Thus, a geographically specific analysis of policy and competitors makes clear that the ILECs no longer possess market power."17

In view of our findings that the ILECs no longer possess market power, we eliminated remaining price constraints on all retail services, but temporarily extended the cap for stand-alone basic and LifeLine service provided by the COLR until January 1, 2009, pending review in this proceeding or in R.06-05-028.18 The rate caps were temporarily continued "in order to address the statutorily-mandated link between the LifeLine rate and basic residential service rates."19 We further concluded that: "After January 1, 2009, the cap on basic residential service rates that are not subsidized by CHCF-B will no longer serve the public interest, and accordingly, the cap will sunset automatically with no further Commission action required."20

In D.07-09-020, we determined that while our ultimate goal remains to rely upon competitive market forces to determine the appropriate pricing of basic services, a transition process is necessary to avoid the potential "rate shock" of sudden, large retail basic rate increases in response to reforms that we adopt herein.21 We have previously noted how a small minority of customers purchase only basic service, and have noted the significant loss of access lines experienced by the ILECs as reported by the FCC.22 We further directed that in Phase II of this proceeding, we would adopt an interim process for a gradual phase-in of any increases to basic rate levels to provide an orderly transition to full pricing flexibility once the current caps expire on January 1, 2009, consistent with URF and B-Fund program reforms.23 Once the transition period is completed, the cap will sunset automatically with no further Commission actions required. Each COLR would be allowed to make any subsequent adjustments in basic rates based on competitive market forces, not based on Commission directive. We do not intend to apply rate caps any longer than is reasonably necessary to promote an orderly transition to full pricing flexibility. Of course, COLRs may refrain from implementing any basic rate increases, depending on competitive market forces in their service areas.

10 Re Alternative Regulatory Frameworks for Local Exchange Carriers, D.89-10-031, 33 CPUC2d 43, 61 (1989).

11 See Re Citizens Utilities Company of California, D.95-11-024, 62 CPUC2d 244 (1995), and Re Roseville Telephone Company, D.96-12-074, 70 CPUC2d 88 (1996), respectively.

12 Re Incentive-Based Regulatory Framework for Local Exchange Carriers, D.95-12-052, 63 CPUC2d 377, 381 (1995).

13 Because the ILEC basic rates were based upon an average between high and low cost areas, basic residential rates in high cost areas were internally subsidized by revenues in more profitable exchanges, subsidies between product lines, and from other sources of revenues. (See D.95-07-050; 60 CPUC2d, 536, 546.)

14 For example, D.98-07-033 adopted $305.2 million in rate reductions in toll, switched access, ZUM/local usage, and custom calling features for Pacific Bell to offset explicit subsidy support from the B-Fund. Companies that did not reduce non-basic rates applied a surcredit on customer bills to offset B-Fund receipts.

15 DIVCA permits inflation-related adjustments to basic rates prior to January 1, 2009, limited to carriers that obtain a statewide video franchise. AT&T, Verizon, and Cox have all received such franchises. Current rates for SureWest and Frontier remain in effect until January 1, 2009.

16 Although the revised rate cap was effective January 1, 2008, AT&T did not actually increase its basic rate to $10.94 until April 18, 2008.

17 D.06-08-030, at 132.

18 In D.06-08-030 as modified by D.06-12-044, we extended the basic service rate cap to any of the services "associated" with basic residential service which are included in the subsidized basic residential service package. However, we did not continue price regulation for "associated" services if they are not included in a subsidized basic residential service package. (See D.06-12-044, OP 1.h., modifying D.06-08-030.). As explained in D.07-09-020, mimeo., pp. 5-6, 78-79, and as used in this decision, "Basic Service" was not subsidized when the CHCF-B support levels were first established. Accordingly, pursuant to D.06-12-044, OP 1.h., the rate cap could not include any of the services "associated" with the subsidized basic residential service package as identified in D.06-12-044, OP 1.h. The rate cap thus did not apply to: local usage; ZUM; EAS; recurring and non-recurring charges; Caller ID; call trace; 976 service; 900/976 call blocking; non-published and unlisted telephone numbers; white pages listings; busy line verification and interrupt services; and inside wire maintenance plans. However, we note that changes to some of these rates may not be permissible where they would diminish the value of basic service. For example, it would be improper to increase ZUM rates that would diminish the 1 MR call allowance value without providing a corresponding increase for that call allowance.

19 D.06-08-030, at 2 and Conclusion of Law 30. The relationship between basic residential rates and funding needed to support the LifeLine program is being addressed in the Universal Service, Public Policy Programs Rulemaking (R.06-05-028). A discount program for low income individuals, LifeLine is a critical element in our universal service program to bring local telephone service at affordable rates to low income Californians. Any changes to basic residential rates have a potential bearing on LifeLine programs. Any effects from this decision that may have a bearing on the LifeLine program are within the scope of R.06-05-028.

20 D.06-08-030 at 152.

21 D.07-09-020 at 49-50, 93-95, OP 8.

22 D.06-08-030 at 119. In addition to the 19% reduction in residential access lines and the 23% reduction in business access lines experienced by AT&T from 2000-2004, we can see that his trend has continued as the most recent FCC Report on the Status of Local Competition, March 2008, indicates that the ILECs in California are serving one million fewer access lines since 2004 despite continued population increases across the state.

23 D.07-09-020 at OP 13.

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