4. Discussion

As a general framework for the transition process for basic rates beginning on January 1, 2009, we are guided by the dual goals of promoting a competitive market-based environment while preserving universal service goals. In particular, we seek to maintain affordable basic service at levels sufficient for at least a 95% penetration rate.

As a basis for determining affordable basic service, our preference is to rely upon market forces rather than cost-of-service studies wherever feasible. In D.07-09-020, we adopted a $36 benchmark for limiting regions eligible for B-Fund support without relying upon cost-of-service studies. We have likewise expressed our preference for using a reverse auction as a means of allocating high-cost support rather than litigating new cost proxy studies of high-cost areas in a lengthy and costly proceeding. Consistent with these preferences for market-based solutions, we likewise decline to conduct cost study updates as a basis to determine the magnitude, timing, and transition period for rate changes in the basic exchange service scheduled to take effect beginning January 1, 2009. There simply is no basis in the record to consider that price regulation based on cost studies is necessary to ensure that the prices are just and reasonable.

Nonetheless, even though we will not rely upon cost studies to determine changes in rate levels for basic service, we recognize that, with the passage of time since the basic rate freeze took effect in 1995, existing rate levels are significantly outdated. Since 1995, consumers have been paying for the basics of life (e.g., a loaf of bread, a gallon of gas, sewer service), and have no reasonable expectation that prices for such basics will remain frozen, given rising costs and inflation during this time period. Further, although we agree with Sprint that in general changes in the price of basic service will have minimal effect of penetration rates for non-ULTS-subsidized customers, we are cognizant that basic economic theory shows that dramatic price changes have different results than normal market-based price changes. Therefore, we have determined that we should navigate a path from the outdated rate caps currently in effect to a more reasonable program that phases in necessary rate increases while allowing the ILECs to more flexibly price their services consistent with today's intermodal market realities.

As part of the framework for a transition plan to implement pricing flexibility for basic rates, it is also necessary to recognize that different considerations apply to: (1) areas subject to B-Fund subsidy support and (2) areas that are not subsidized by the B-Fund. As noted in D.06-08-030, even in a competitive market, CHCF-B subsidies can distort the market for the provision of basic stand-alone service. Accordingly, we adopt a transition plan leading to full basic service pricing flexibility in regions not subsidized by the B-Fund while retaining restrictions on the maximum rates that a COLR may charge in high-cost areas in order to qualify for B-Fund support. By tying the rates in areas subsidized by the B-Fund to the rates in areas not subsidized by the B-Fund we provide a "backstop" mechanism in areas subsidized by the B-Fund so that those rates will be determined through market forces prevalent throughout California.

During an initial transition period, we shall continue to restrict the maximum rate for basic service that each ILEC may charge for stand-alone basic service throughout its service territory. Given the length of the rate freeze (13 years since 1995) and the fact that AT&T basic rates remain more than $8 below the national average for monthly household expenditures for telephone service, the potential exists that the AT&T basic rate is abnormally low. By limiting rate increases during this transition period, the risk of consumer rate shock is avoided. Once the transition period expires, the ILECs will acquire full pricing flexibility in regions not subsidized by the B-Fund. In regions that continue to be subsidized by the B-Fund, the COLR (the ILEC and/or any successor carrier(s) assuming the role of COLR) must certify that its basic rates do not exceed 150% of the highest basic rate that it charges in non-high-cost areas in California.

We therefore must resolve the following issues associated with transitioning basic rates to reflect competitive market forces:

· Length of the transition period;

· Maximum year-to-year increase allowed in basic rates during the transition period; and

· Maximum cumulative increase allowed in basic rates during the transition period.

We find that implementing a transition to flexible pricing for basic service is consistent with URF policies, because it moves basic service rates toward a level that reflects competitive market forces. Particularly in view of the extended period that basic rates remained frozen despite changing market dynamics, allowing for increases in basic rates is appropriate and fair.

While our ultimate goal is to rely upon competitive market forces to determine the pricing of basic services, we stated in D.07-09-020 that a transition process was necessary to avoid potential consumer "rate shock" once the cap expires on January 1, 2009. In this decision, therefore, we adopt a phase-in process to provide an orderly transition, and to ensure reasonable and affordable rates as required by Pub. Util. Code § 451.

In D.07-09-020, we took an important step in better targeting B-Fund support by raising the threshold to $36 for qualifying as a high-cost area. Accordingly, for residential lines in regions no longer subsidized by the B-Fund, it is reasonable to allow basic rates to adjust to levels dictated by competitive market forces, thereby promoting economic efficiency. We determine it is not necessary or desirable to conduct lengthy and expensive cost-of-service studies as a basis for determining rate changes. We believe that the telephone marketplace is very vibrant in California, with head-to-head competition throughout the state, involving incumbent phone companies, wireless carriers, and VoIP providers, particularly cable and over-the-top VoIP carriers, as well as traditional competitive local exchange carriers. We note that the rate freeze set in the mid 1990s was predicated upon certain cost-of-service assumptions. In particular, rates were set at a level to recover only 50% of the fully allocated cost of providing basic service. The remaining 50% of the fully allocated costs was to be recovered through non-basic rate elements. By maintaining the rate freeze for an extended period, the disparity between market forces and regulated prices for basic service became more pronounced as time passed. Consistent with our goals to achieve toward more market-based pricing, we adopt measures herein for step increases in the basic rates.

For purposes of developing a transition plan for basic rates to increase after the freeze is lifted on January 1, 2009, it is useful to consider how the ILEC currently recovers the costs associated with basic service. For those lines for which basic service is provided on a stand-alone basis, customers pay no more than the authorized rate cap. By contrast, where a bundle of services are provided together with basic service, the customer pays a market rate for the entire bundle. Another distinction in cost recovery may apply between basic service provided in high-cost regions where the ILEC receives B-Fund subsidies versus those lines served outside of high-cost regions with no subsidy.

With high levels of competition in California, our goal is to phase out all rate caps. The Commission will continue to monitor the market to guard against abuses, however. In order to ensure that the full benefits of competition are maintained in affordable rates throughout the state, we will create a new backstop rate cap in those regions where high-cost support payments apply. In those regions where high-cost support payments will continue to apply, basic service rates will continue to be restricted to a level no higher than (a) 150% of the highest rate charged by the ILEC (and/or a successor COLR(s)) in its California service area outside of any subsidized high-cost areas, as explained further below, or (b) the $36 high-cost benchmark minus the EUCL, whichever is lower.28 The 150% threshold continues the Commission's longstanding policy of providing high cost universal service support only after local exchange rates go up to, but not to exceed, 150% of comparable California urban rates.29 To the extent any differential in rates exists, we believe that the highest rate in an area that is not receiving high cost support is the most comparable to those areas that are receiving CHCF-B support, and thus use that rate as the benchmark for this "backstop" mechanism.

Moreover, in the event that applying the 150% limitation was to result in a stand-alone basic rate plus the EUCL exceeding $36 (the currently effective high-cost benchmark), the stand-alone rate must be reduced to $36 minus the EUCL. Otherwise, the COLR would no longer be entitled to continue to receive B-Fund subsidy. It would be an abuse of the B-Fund program for a COLR to receive both B-Fund subsidy for costs above the $36 benchmark and revenues for the same purpose through basic rates.

Another transitional matter is the phase-out of surcredits relating to B-Fund subsidies. D.07-09-020 noted that in order to offset B-Fund subsidies, Frontier and Verizon each apply a surcredit to their customers' bills for all intrastate services except basic residential service. In D.07-09-020, we stated that these surcredits should be phased out in a series of steps in tandem with the schedule for revisions to the benchmark and corresponding reductions in B-Fund draws, to be completed by July 1, 2009. We thus expressly authorize Frontier and Verizon to complete the phase-out of their surcredits to conclude as of July 1, 2009. The phase-out of the surcredits is conducive to the goal of moving more toward reliance on competitive forces rather than subsidies to meet universal service goals.

We shall adopt a two-year phase-in period for transitioning to full pricing flexibility for basic service. During the phase-in period, we shall continue to constrain the maximum rate that the ILEC may charge for basic service. In reaching this result, we balance countervailing goals. We seek to avoid consumer "rate shock" by not immediately allowing full pricing flexibility after the current rate freeze expires on January 1, 2009. We disagree with Sprint's claim that competition in the marketplace would fully prevent any "rate shock" as a result of immediately eliminating all controls on basic residential rates. Although the voice market is competitive, basic residential rates have not been priced at competitive market levels, but were frozen at 50% of the fully allocated cost of providing basic service for well over a decade. As observed in D.06-08-030, subsidized pricing of basic service distorts market processes. Therefore, in view of these market distortions, a transition period will allow for an orderly movement to a competitive environment.

In comments on the PD, certain parties object to any continuation of basic rate limitations beyond January 1, 2009, but instead advocate immediate removal of any and all constraints. AT&T, for example, argues that extending any limits on basic rates for an additional two years beyond January 1, 2009, would constitute a "step backwards" from the direction laid out in the URF proceeding. Cox, Sprint, and T-Mobile express similar arguments arguing that no transition period is needed.

The transition plan we adopt herein is entirely consistent with URF. In D.06-08-030, we expressly ordered that "basic residential services receiving a CHCF-B subsidy shall be frozen at a level equal to the current rate, which will be reevaluated in our upcoming CHCF-B review in R.06-06-028." (D.06-08-030 at 143.) In D.07-09-020 (in Phase I of the instant proceeding), we expressly affirmed that, upon expiration of the basic rate freeze for each ILEC, a phased-in implementation of rate cap increases should take effect to move from current levels up to the revised level of the benchmark threshold.

In this regard, D.07-09-020 stated:

Although the basic rate freeze will end on January 1, 2008,30 we conclude that it would be premature to grant full pricing flexibility for all basic rates immediately. . . . Therefore, we shall adopt a phased-in schedule to take effect beginning January 1, 2008, to begin transitioning from the current basic rate levels toward the goal of cost-based rates, as disciplined by competitive market forces. During this phase-in period, we shall impose caps on the maximum level that the COLR may charge for basic service, subject to gradual step increases over a prescribed time period until the rate cap rises to a level to be determined in Phase II. In this manner, any potential "rate shock" will be avoided.

Therefore, our transition plan implements the principles previously adopted in D.07-09-020. By objecting to any transition period beyond January 1, 2009, parties are attempting to reargue principles that have already been adopted in D.07-09-020. Accordingly, such objections are procedurally improper and without merit.

On the other hand, an excessively prolonged period of artificially low prices would unduly impede progress toward unimpeded competitive market pricing as envisioned in the URF proceeding. Moreover, while we will maintain appropriate measures to ensure that stand-alone basic service remains available and affordable throughout the state, there is no valid basis to perpetuate anachronistic rate levels that distort price signals.

While certain parties propose a transition period longer than two years, we find that prolonging rate caps beyond two years would unduly delay progress toward market-based pricing. URF was decided in August 2006, and the basic rates for the URF carriers have been frozen by this Commission until January 1, 2009 in this proceeding (and others related to it) were completed. This time period should also be factored into our considerations. Since D.06-08-030 was issued in URF, we have noted vigorous levels of competition for telephone service in California, with aggressive head-to-head competition between ILECs and competitors including cable systems using either VoIP or CLEC authority. Further, we have seen wireless phones become entrenched with our residents, with more wireless phones than wireline phones in our state.31 Recent statistics show that 15.8% of California households are wireless only, a trend we expect to see continue.32 Thus, a two-year phase-in period, beginning January 1, 2009, strikes the appropriate balance in protecting customers from rate shock while progressing forward to achieve the benefits of competition. We conclude that the maximum rate changes allowed over the two-year transition period, as well as any potential rate changes after the transition period expires is sensible in light of market conditions. We believe this phased transition period will preserve the affordability of basic service, as well as the market based rates that will result after the two year period ends.

We expect competitive market forces to constrain basic service price increases above affordable levels in areas that are no longer eligible for B-Fund subsidies. Given these considerations, we find no necessity to conduct an "affordability study" as a basis to determine the nature and extent of any future rate controls subsequent January 1, 2011. Conducting an affordability study, as proposed by DRA and TURN, is not warranted, particularly in view of the resources that such a study would require. An affordability study would require first an estimation of the demand function for local telephone service, that is, measuring the correlation of price changes with the quantity of local service demanded.33 The resource-intensive work required to litigate such a study is not necessary since market forces can be relied upon to balance supply and demand for basic service. In addition, we did consider the most recent Study on Affordability of Basic Telephone Service conduced by Field Research Corporation in 2004 ("Affordability Study") when we established the new high cost benchmark. We rejected using those results as the both mean and median total cost per month of respondents were significantly higher than their actual monthly cost, and almost the same or in most cases higher than new high cost benchmark. As more than 82% of respondents did not find phone service difficult to afford and the median monthly bill, excluding wireless, was reported by those respondents to be $35 (in 2004 dollars). The proponents of a new Affordability Study have failed to explain how such a study would be used to establish rates for any communication service. The proponents offer no precedent and the Commission has not found any state or nation where such an approach was used to establish rates. Finally, the proponents are effectively arguing that we should repeat a study to establish new rates at levels significantly higher than we approve herein. We do not find anything in their comments to contradict the findings of D.06-08-030 or D.07-09-020, or that an Affordability Study will produce results in any way contrary to those findings. We reject the use of the Affordability Study as a basis for establishing basic rates.34 However, we do find merit in conducting another Affordability Study as it has proven useful in the context of evaluating the California Lifeline program. We believe that the Commission should undertake such an Affordability Study in the 2009-2010 fiscal period and will request an appropriation from the Legislature to conduct such a study as part of its ongoing evaluation of the California Lifeline program in R.06-05-028.

Further, in the designated high-cost areas where B-Fund support will continue to be provided after the transition period concludes, we will take an additional step to ensure that basic rates remains affordable. Thus, while we expect the same market forces to constrain prices in high-cost areas, in those areas where a COLR is receiving high cost support we will add an additional backstop (to limit basic rates based on the 150% limitation as described above) that will ensure prices are affordable and reasonably comparable to areas that have lower costs of service.

In comments to the PD, various parties object to our basic rate transition plan, but for different reasons. Although TURN and DRA claim there is no record to show that basic rates will remain affordable under the transition program as set forth in this decision, they disregard the record in the URF proceeding. As found in D.06-08-030, the URF ILECs "lack the market power needed to sustain prices above the levels that a competitive market produce" and "market conditions support pricing freedoms for basic residential rates that are not subsidized by the CHCF-B or LifeLine." These Commission findings provide a proper record to support the transition to full pricing flexibility for basic service adopted herein. Moreover, the protections precluding the COLR from raising basic rates above 150% of its highest rate outside of high-cost areas provide an additional backstop to ensure affordability.

We likewise are not persuaded by parties' opposition to the PD that argue that since competition exists even in high-cost areas, there is no need for any further regulatory constraints at all on basic service prices. To the contrary, although we recognize that the marketplace is competitive, we have also determined that B-Fund protections continues to be appropriate to help preserve affordable service in high-cost regions after January 1, 2009, as D.07-09-020 states:

While competitors have the capability to serve high cost areas without B-Fund support, however, competitors also reasonably expect to recover their costs. Until we update the relevant proxy associated with providing basic service in high cost areas (scheduled for the next phase of this OIR), we cannot confirm that ubiquitous cost-based pricing for basic service would remain affordable without the B-Fund. (D.07-09-020 at 33.)

Thus, even with a competitive market, we expressed concern in D.07-09-020 that competing carriers could incur costs to serve certain customers in remote or hard-to-reach areas that are higher than in more populated regions. As a result, without B-Fund protections, competitors might decline to serve, or raise basic service rates to unaffordable levels for such customers. Thus, as noted in D.07-09-020, even within a competitive market, B-Fund pricing protections remain appropriate as a backstop to ensure affordability in high-cost regions. The price protections adopted herein are thus fully consistent with our findings that markets are competitive.

We shall authorize increases in the stand-alone basic rate cap over a two-year period for service offered by each respective ILEC, limited to the amounts set forth in Appendix 2. These rate cap increases shall apply to basic service offered to residential customers throughout the ILEC service territory). The rate cap increases that we authorize, both on an annual and cumulative basis, appropriately balance the objectives of avoiding rate shock while allowing for timely transition to market-based pricing.

In assessing the appropriate magnitude of rate cap increases during the transition period, we turn our attention first to AT&T. Many parties argue that because the current rate cap of AT&T remains significantly lower than that of the other three ILECs, a relatively larger increase is warranted for AT&T. We expect that absent the rate freeze, the rate disparity between AT&T and the other ILECs will narrow given normal competitive forces. We are not persuaded that policies simply designed to narrow the rate disparity will promote a more competitively level playing field. Competitive forces, income levels and costs vary by specific region, and thus, some disparities will be expected and normal.

We do not agree the proposal both of DRA and AT&T to reduce the disparity in basic rates between AT&T and the other ILECs rises to the level of a goal of the Commission. We also decline to adopt a one-year increase as large as that proposed by AT&T and Verizon. In the interests of minimizing the risk of rate shock, we conclude that a more modest increase is warranted.

We do not necessarily agree with the arguments of AT&T and Verizon that based on rate increases previously authorized in D.94-09-065 (the IRD proceeding), an annual increase as high as $6.05 would be defensible here, as conditions were different in 1994 at the time we approved basic service rate increases of $6.05 in D.94-09-065. For example, as a consideration in approving the $6.05 increase in basic rates in D.94-09-065, we concurrently adopted lower toll calling plans. Consequently, we observed that customers who made toll calls would not experience a full $6.05 increase in their overall monthly bills as a result of offsetting bill decreases from lower toll calling charges. By contrast, however, while the reduction in the CHCF-B surcharge is significant, it alone does not offset an increase as large as $6.05. Further, because non-basic rates were deregulated after the URF decision in August 2006, AT&T has increased rates for many unregulated features for California subscribers. Therefore, a relatively more modest monthly rate increase is warranted here.

We find merit in TURN's proposal to limit rate increases based upon the rate of inflation. But rather than simply considering inflation on a prospective basis, it is reasonable to recognize the effects of price inflation that have accumulated since basic rates were frozen in the mid-1990s. As a benchmark for purposes of measuring the cumulative increase in the AT&T rate before the transition to full pricing flexibility, therefore, we find it reasonable to apply the cumulative effects of consumer price inflation over the period since the basic rate was frozen in 1995.

In D.94-09-065, the Commission set basic service rates for AT&T at $11.25 for the residential flat rate and $6.00 for the residential measured rate. These rates remained in effect from January 1995 until November 1999 when the basic rate was further reduced to $10.69 in compliance with D.94-09-065, which directed actual price changes when permanent surcharges or surcredits total 5% or more on a cumulative basis. In 1999, AT&T California's surcredit reached that level for a variety of reasons, including annual price cap filings. The rate of $10.69 remained in effect until April 2008 when AT&T was authorized to increase its basic rate to $10.94 to account for one year of inflation pursuant to D.07-09-020.

During the intervening period that basic service rates remained frozen, the cumulative effects of price inflation resulted in the true economic retail charge for basic service actually declining when measured in terms of real inflation-adjusted purchasing power. Therefore, by allowing for basic rates to increase by the cumulative effects of inflation-adjusted price level changes, we are merely restoring the price of basic service to its real inflation-adjusted value in relation to 1995 price levels. Such an approach is clearly consistent with the goal of affordability. Thus, while the resulting rate increases represent a higher cost in nominal dollars, the increase does not constitute a significantly higher share of consumers' overall purchasing power, in terms of real inflation-adjusted dollars. By limiting the increase in the basic rate equal to the cumulative rate of inflation over this period since rates were frozen, we thereby preserve affordability of basic service.

Based upon our calculation as summarized in Appendix 1, assuming that the effects of inflation had been incorporated each year into basic service rates from 1995 through 2008, the inflation adjusted amount for the basic flat rate would be $16.14, representing a cumulative increase of $5.20 through 2008. Taking into account an estimated CPI inflation rate for 2009 and 2010 of 3.94%, the cumulative increase carried through 2010 would be $17.44 (i.e., $16.14 x 1.0394 x 1.0394). The cumulative increase over two years would be $6.50 (i.e., $17.44 - $10.94). Since the rate increase is phased in over a two-year period, one half of this amount, or $3.25 would be applicable each year.

Accordingly, we authorize AT&T to phase in this increase in its monthly basic rates by $3.25 per line effective January 1, 2009, and by an additional $3.25 per line effective January 1, 2010, equivalent to the cumulative increase in nominal dollars required to adjust for inflation as measured by the consumer price index from 1996 through 2010.

The annualized rate increase that we adopt for AT&T strikes an appropriate balance, higher than the amount proposed by DRA but lower than the amount proposed by AT&T and Verizon. At the same time, the total cumulative increase that we authorize for AT&T during the transition period is less than the cumulative increases proposed by the parties. While we are lifting restrictions on the ability of AT&T to impose further increases after January 1, 2011, we conclude that the forces of competition, together with the 150% basic rate limitation in high-cost areas, will constrain AT&T from increasing the rate above affordable levels going forward.

While the basic rates for Verizon, SureWest and Frontier have also been frozen since the mid-1990s, those rates remain significantly higher than the rate charged by AT&T. If we were to allow the other ILECs rates to increase on an equivalent percentage basis for the cumulative effects of past inflation, the dollar-amount of increase would be higher as compared with AT&T, and consequently, we would simply maintain the rate disparity between AT&T and the others. We conclude instead that an identical dollar-amount increase in the basic rate as we authorize for AT&T is appropriate for them during the two-year transition period, resulting in a lower percentage increase compared to AT&T. By adopting the same dollar-amount increase in the basic rate for the other three ILECs, we will be able to meet our goal of avoiding rate shock for customers as the carriers move toward market-based pricing.35 As a result of applying the same rate cap dollar increase for all four ILECs, we will facilitate a smoother transition to market-based pricing once the two-year transition expires.

For the three ILECs other than AT&T, therefore we shall allow annual increases in their monthly rate caps equivalent to the AT&T amount of $3.25 effective January 1, 2009 and 2010, respectively. As noted previously, we concurrently 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%.36 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.37

We direct parties in the Universal Service Docket (R.06-05-028) to file comments on September 30, 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.06-06-028, including the final LifeLine basic rates, with an effective date of January 1, 2009.

The effects of the authorized increases in the caps for basic flat rate service for each of the ILECs is summarized below:

Revised Dollar Amount of the Basic Flat Rate Caps (by carrier)

Currently Effective AT&T Verizon SureWest Frontier

Basic Rate $10.94 $17.66 $18.90 $17.85

EUCL 4.40 6.50 6.50 6.50

Total $15.34 $24.16 $25.40 $24.35

Rate Change Date

Rate Increase ($) AT&T Verizon SureWest Frontier

1/1/2009 3.25 3.25 3.25 3.25

1/1/2010 3.25 3.25 3.25 3.25

Total Revised basic rate (by carrier)

1/1/2009

Basic Rate 14.19 20.91 22.15 21.10

EUCL 4.40 6.50 6.50 6.50

Total 18.59 27.41 28.65 $ 27.60

1/1/2010 AT&T Verizon SureWest Frontier

Basic Rate 17.44 24.16 25.40 24.35

EUCL 4.40 6.50 6.50 6.50

Total $21.84 30.66 $31.90 $30.85

The applicable percentage increases in the flat rate for each ILEC as a result of applying the uniform $3.25 increase effective beginning January 1, 2009 and January 1, 2010, respectively, are summarized below:

Percentage Increase in Authorized Basic Rate Cap

Effective

               

Date

AT&T

 

Verizon

 

SureWest

Frontier

 

1/1/2009

$10.94

 

$17.66

 

$18.90

 

$7.85

 
 

$3.25

 

$3.25

 

$3.25

 

$3.25

 

% Increase

30%

 

18%

 

17%

 

18%

 
                 

1/1/2010

$14.19

 

$20.91

 

$22.15

 

$21.10

 
 

$3.25

 

$3.25

 

$3.25

 

$3.25

 

% Increase

23%

 

16%

 

15%

 

15%

 

Consistent with these authorized increases in the rate cap for basic service under the flat rate option, we correspondingly authorize increases of the same magnitude for basic service offered under the measured rate option. Since the measured rate is billed as a function of a customer's usage, rather than as a flat amount, we shall derive the applicable increase in the measured rate cap by applying the same percentage increases as derived above for the flat rate.

The increases calculated on an annualized basis for the ILECs represent a much smaller average relative increase when taking into account the extended period during which there were no basic rate increases (and when the inflation-adjusted value of the basic service rate actually declined).

The rate increase caps for basic flat and measured rate service that we adopt herein shall continue to apply to the provision of service by the COLR in each of the respective ILEC service territories for the two-year transition period beginning January 1, 2009. We note, however, that concurrent proceedings are underway to implement a reverse auction process whereby different carriers may be selected as COLRs in one or more service regions during the transition period.38 If different carriers were to assume COLR responsibilities before the end of the phase-in period, at a minimum, customers of the original COLR would be able to transfer to the new COLR in order to continue to receive basic stand-alone service while preserving affordability, dependant on the transition rules adopted in a subsequent phase of this proceeding. In our subsequent decision adopting the reverse auction protocols, we shall address the process whereby the customers of the original COLR will be apprised to any change in COLR(s) and provisions for switching service in order to maintain stand alone basic service at an affordable COLR rate.

At the end of the two-year transition period, we reaffirm that full pricing flexibility is allowed for stand-alone basic service within those regions that are not subsidized by the B-Fund. The ILECs will be free thereafter to adjust residential basic rates in areas not subject to Lifeline subsidy or B-fund, based on competitive market forces. As of January 1, 2011, the URF ILECs may change their basic rates by filing a Tier 1 advice letter. The ILECs will be able to price residential service by geographic area rather than being required to apply uniform prices in all areas. A requirement of geographically averaged prices could encourage the provision of services by high-cost but subsidized technologies, while discouraging service by competitors offering lower-cost but unsubsidized services.39

As a result of the transitional rate increases that will be allowed over the two-year period, we will avoid the risk that any subsequent increases will result in consumer rate shock. We believe that competitive market forces will provide an effective check to keep any subsequent basic rate adjustments after January 1, 2011 at affordable levels. We have already determined in D.06-08-030 that the market for telecommunications services is competitive and that the ILECs no longer possess market power. Thus, the ILECs would not be able to sustain rate increases for basic service above affordable levels, particularly in areas that are not subsidized by the B-Fund. As we stated in D.06-08-030, cross-platform competition, particularly from wireless and VoIP technologies, constrains the ability of an ILEC to raise basic rates.40 Even where competitors do not offer an exact equivalent to the stand-alone basic service that is available from the ILEC, the competitive pricing of service packages offered by competitors will still serve as a check against increasing the basic service rate beyond an affordable level.

Therefore, it is not necessary to make findings concerning the precise magnitude of rate changes in basic service that may be deemed affordable subsequent to January 1, 2011. Although we set a threshold of $36 per line in D.07-09-020 as a generalized measure of affordability for purposes limiting eligibility for B-Fund subsidy support, we expressly affirmed that the $36 threshold was not intended for use as a stand-alone rate for basic service. We expressly made this clarification in D.07-11-039, and affirm it again today.

While we set the high-cost benchmark at $36 per line in D.07-09-020, the level of the high-cost benchmark does not necessarily constitute an affordable stand-alone basic rate. As we stated in D.07-09-020:

The $36 benchmark, however, is in no way intended to serve as a cap on basic rate levels, or as a determination that retail rates for basic service alone as high as $36 would be affordable. Likewise, this benchmark level does not indicate that we believe it is appropriate for basic service to rise to a level of $36 per line. (D.07-09-020 at 46.)

Therefore, even though we set the benchmark at $36 per line for eligibility to claim B-Fund support, we do not create any correlation between the benchmark for determining where high cost support is appropriate and rates.

Even if there was a correlation, the $36 threshold was based upon national aggregate data that incorporates revenues for bundles of telecommunications services. So while TURN tried to calculate how much of the $36 benchmark for high cost support contemplates a basic rate level lower than

$36,41 it errs in this approach because the Commission has not set the $36 figure as any kind of benchmark for determining that price regulation is no longer needed to ensure that prices are just, reasonable and affordable. Actual adjustments in the basic rate will be a function of competitive influences, marketing strategies of the ILEC, as well as actual changes in costs and technologies over time. Even if the ILEC relied exclusively on the revenues from the stand-alone basic rate to recover its costs, the currently assumed cost proxies that are set below the $36 level do not accurately measure the actual costs that would be incurred to provide basic service based on today's most efficient technology. The pricing of basic service will be set in the context of the overall market environment, taking into account revenue-generating opportunities from bundles of product offerings marketed to customers. As we stated in D.07-09-020, the ILECs have considerable flexibility under our URF regulatory regime to bundle a variety of features (e.g., voicemail, call forwarding, Caller ID, etc.) together with the primary basic residential line offered to its retail customers. Even though the primary line remains subject to regulatory price controls, the ILECs have flexibility under URF to adjust its prices for additional services bundled with the basic line, constrained only by competitive forces. In applying the $36 benchmark to determine high cost areas, we appropriately took into account this broader context in which residential lines are marketed with the flexibility to bundle the basic line with additional features and to flexibility price those additional features.

While we make no findings as to the precise magnitude of basic rate changes deemed affordable subsequent to January 1, 2011, we conclude that it is appropriate to continue to restrict the maximum stand-alone rate, as noted previously, by an amount not to exceed 150% of the highest stand-alone rate charged by the COLR in its California service area outside of high-cost regions or $36 minus the EUCL, whichever is lower. As discussed below, we shall adopt appropriate measures to ensure that as a condition of receiving B-Fund support, COLR stand-alone basic rates meet this requirement.

We also will continue to monitor the residential telephone subscribership in California to ensure that the metric we use as a determination that services are affordable remains above 95%. At this point there is no need to maintain broad all-encompassing policies for wireline telephone service. The Commission can best assure the continued affordability of telecommunications services through targeted programs and policies such as California Lifeline and the CHCF-B. Further, the Current Population Survey (CPS) that the Commission uses to measure telephone subscribership may "be on the low side" and any action based on its results should use it in a conservative manner.42 Accordingly

the Commission may choose to evaluate its existing programs and consider new targeted programs should the CPS penetration rate for telephones available to households fall below 95% for an entire year.43

In areas where costs of service exceed the high-cost threshold, (i.e., currently defined as regions in CBGs with an assumed cost in excess of $36 per line), as previously decided in D.07-09-020, B-Fund support will continue to be available to supplement revenues collected through the end-user's basic rate. Therefore, after the two-year transition period expires, the basic rate charged in high cost areas shall continue to be subject to the 150% limitation, as explained above, as a backstop to ensure affordability. As a basis to receive B-Fund support after full pricing flexibility takes effect, we stated in D.07-09-020, that further guidance would be provided regarding measures to ensure that the COLR will not increase charges for basic service above an affordable level. The B-Fund subsidy support is provided to a COLR on the condition that the basic rate that is charged to the end user will not exceed a prescribed maximum.

As stated in D.07-09-020 (ordering paragraph (OP) 9), as modified by D.08-04-061, a COLR will be required to certify annually that rates for basic service within its designated high-cost area:

"do not exceed a level consistent with the authorized amount of B-Fund support pursuant to further disposition in Phase II of this proceeding."

The intent of OP 9 of D.07-09-020, as modified by D.08-04-061, is to ensure that the COLR does not charge more than what would otherwise be affordable in areas that are not subsidized by the B-Fund. In order to implement this goal, we shall require that the COLR certify that it does not charge stand-alone basic rates in high-cost areas (a) that are more than 150% of the highest rate for stand-alone basic service that it charges within its aggregate California service territory not subsidized by the B-Fund, or (b) that are more than the $36 high-cost benchmark minus the EUCL, whichever is lower.44 Since this rate will be subject to pricing flexibility after January 1, 2011, some additional reporting requirements will be necessary to provide the requisite data to ascertain the highest stand-alone basic rate in the COLR's California service area outside of high-cost areas. We shall address the details of how this process of verifying the highest rate in our subsequent decision adopting protocols for the reverse auction.

A COLR that does not make the required annual certification will be required to provide a detailed showing as to why it is unable to comply with the Commission's orders. The Commission will evaluate the evidence and determine what, if any, action is required. As part of the bidding process, we expect that as a condition of winning the bid for a given level of support in high cost areas, the winning bidder must agree to limit the maximum that it will charge customers for basic service in the high-cost areas. Therefore, the COLR must certify that the charge for stand-alone basic service does not exceed the maximum amounts deemed affordable, as described above.

A reverse auction mechanism is now being considered which will develop parameters to determine the level of support that will apply in remaining high-cost areas. The maximum rate levels that may be charged within a given high-cost area will serve as one of the factors to be taken into account in bidding on B-Fund support levels in the reverse auction. The winning bidder will be expected to bid on the minimum level of subsidy that it will require as condition of serving as COLR for the period designated, subject to a limitation on maximum charges for residential basic service in designated high-cost areas, as prescribed above.

28 As an illustration of how the 150% limitation applies, if the highest stand-alone rate charged by a COLR in California outside of high-cost areas was $18 (excluding EUCL, taxes, and surcharges), after December 31, 2010, this same COLR could increase basic stand-alone rates within a high-cost area by no more than 50% above the $18 rate, an increase equal to $9. Thus, the COLR's stand-alone basic rate in the high-cost area could not exceed $27 (=$18+$9).

29 See, Alternative Regulatory Frameworks for Local Exchange Carriers, D.91-05-016, 40 CPUC2d 40 as modified by Alternative Regulatory Frameworks for Local Exchange Carriers, D.91-09-042, 41 CPUC2d 326 at Appendix B. CHCF-A guidelines require a small LEC's CHCF-A requirement to first be met by increases in its local exchange rates up to, but not to exceed, 150% of comparable California urban rates. After this rate limit has been met, the small LECs can then apply for CHCF-A funding if they make regular GRC filings. TURN proposes we constrain the basic rate in all areas through a similar means by not permitting rates in excess of 150% of the lowest rate that the service provider charges in the state. TURN Comments on Phase II ACR at 48-49.

30 The rate freeze was lifted on a limited basis on January 1, 2008 for AT&T and Verizon pursuant to DIVCA, which allows inflation-related rate adjustments for eligible carriers prior to January 1, 2009. Subject to this limited exception, the currently effective URF ILEC rate freeze is scheduled to expire effective January 1, 2009.

31 FCC Local Telephone Competition: Status as of June 30, 2007 (Mar. 2008) at Tables 7 and 14 (as of June 2007, there were 30,203,842 wireless subscribers in California compared to 18,485,441 ILEC and 2,898,469 CLEC switched access lines in California).

32 Centers for Disease Control and Prevention National Center for Health Statistics, Wireless Substitution: Early Release of Estimates from the National Health Interview Survey, July-December 2007 (nearly one out of every six American homes (15.8%) had only wireless telephones during the second half of 2007, and more than one out of every eight American homes (13.1%) received all or almost all calls on wireless telephones despite having a landline telephone in the home).

33 See Sprint Reply Comments at 10, dated November 28, 2007.

34 The Affordability Study has been useful in the past to show how and why the California Lifeline Program is an important component of our overall strategy to maintain a high subscribership rate. We note that approximately 25% of households in California are subscribers to California Lifeline, and that as part of the overall reforms to the California Lifeline programs being considered in R06-05-028 we expect that an update to the Affordability Study will be useful in ensuring that our policies continue to meet the goal of 95% subscribership. As the number of California Lifeline households exceeds those that found telephone service difficult to afford or had concerns about paying their phone bill, we believe that the results of the 2004 Affordability Study are entirely consistent with our reliance on California Lifeline to address affordability issues. The use of an Affordability Study will not produce helpful or usable information related to matters in this docket.

35 We note that the Commission has previously determined that the basic rate offered by SureWest is just, reasonable, and affordable for California consumers. If we were to apply the full CPI adjustment to this SureWest rate, we could extrapolate a significantly higher basic rate percentage increase that would be just, reasonable, and affordable. However, since the marketplace will ensure that prospective rates remain just, reasonable, and affordable we do not engage in this analysis.

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

37 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.

38 Issues such as to whether one or multiple carriers may serve as COLRs within the same high-cost region and possible revisions in the basic service definition to promote more technology-neutral standards will be addressed in a subsequent decision adopting reverse auction protocols. We make no prejudgment of those issues here.

39 For example, in many rural areas, it may prove less expensive to provide basic service via wireless technologies than by subsidizing the construction of long copper wire traditional telephone service connections.

40 D.06-08-032, at 132.

41 By extrapolating a figure is 69.9% higher than the nationwide median basic service rate of $14.25, by excluding the subscriber line change (SLC) and other taxes and fees TURN believes that $21.19 represents the portion of the $36 that is attributable to basic service. Applying this 69.9% ratio to the service offerings of the ILECs, TURN computes the basic service rate element would represent $21.19 (i.e., $21.19 * 1.699 = $36). See TURN Comments of 11/29/07 at footnote 14, citing Table 1.1 in the 2007 FCC Reference Book of Rates, Price Indices and Household Expenditures for Telephone Service, http://fjallfoss.fcc.gov/edocs_public/attacmatch/DOC-276876A1.pdf. However, TURN does not account for the impact of the frozen basic rates in California on the originating data set. In addition, other assumptions could increase or decrease the figure calculated by TURN. In any case, since the $36 figure is used in calculating where California will provide high cost support and that calculation does not consider whether the actual rate is higher or lower than the benchmark, their extrapolation is not probative in our analysis.

42 CPUC Universal Service Telephone Report to the California Legislature at 3-4, May 2008.

43 The CPS survey is conducted every month, but not all questions are asked every month. The telephone questions are asked once every four months. As the sample is staggered, reported information for any given month actually reflects responses over the preceding four months. The FCC aggregates summaries of the responses based on the surveys conducted through March, July, and November of each year.

44 If the COLR does not offer stand-alone basic residential service outside of high-cost areas, the highest stand-alone basic rate offered by an adjacent ILEC may serve as a suitable proxy.

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