VIII. Depreciation

A. RTC

RTC requested that the requirement to annually file for approval of depreciation rates be eliminated. RTC stated that this requirement treats it differently than Pacific, Verizon and its competitors. RTC referred to the following language in D.98-10-026.

"We agree with Pacific that the lack of competitive neutrality in depreciation regulation harms competition, consumers and incumbent firms. The harm results from possible negative effects on investment decisions, leaving consumers with higher prices and fewer services. The negative influence occurs when investment decisions are skewed by regulated depreciation rates (if not equivalent to market depreciation rates) used in economic analyses for some firms but not others. We also agree with GTE that this asymmetry subjects GTE and Pacific to administrative costs not required of CLCs, and is needless with the suspension of sharing. Thus, our concern about competitive neutrality, and desire to level the playing field whenever possible, persuades us to permanently eliminate depreciation reviews and approvals."

RTC stated that, given these findings, there is no reason to continue the depreciation filings.

RTC states that by eliminating annual depreciation reviews, the Commission would shift the risk and reward of future investment decisions from ratepayers to shareholders. This will establish a risk-reward structure commensurate with what NRF was established to accomplish and on par with the evolving competitive marketplace.

RTC states that in D.98-10-026, the Commission found that elimination of depreciation reviews would permanently foreclose any potential franchise impact claim with respect to new investments and depreciation from the effective date of the decision. The Commission rejected the suggestion that the elimination of depreciation reviews would foreclose potential franchise impact claims with respect to investments made before the requirement was eliminated. The Commission also stated that it cannot rule out any stranded cost claim for past investments and depreciation. RTC requests that the Commission should make a similar statement in this proceeding.

RTC alleges that there is no need for a final depreciation study as proposed by ORA. Even if the result would be an increase in depreciation accruals, the effect on sharing would be minimal. However, if the Commission does order a final depreciation review, it should allow RTC to recover any increased expense through a revenue increase. This would be done either through increased prices or through the Z factor or Limited Exogenous (LE) factor mechanism.

RTC does not object to working with ORA to provide information on depreciation. However, it opposes ORA's proposed annual reports because they are not required from Pacific or Verizon.

B. ORA

ORA does not oppose eliminating annual depreciation filings so long as RTC is required to adhere to the following requirements which were imposed on Pacific and Verizon in D.98-10-026.

· Permanently give up any potential franchise claim covering investment and depreciation for future investment;

· Do not request changes in customer rates due to changes in depreciation rates; and

· Determination of Z-factor treatment of depreciation changes resulting from the move towards economic lives should be determined only after a review of the magnitude and the cause of the change.

ORA recommends that RTC also be prohibited from recovering any franchise impact claims resulting from past investments. ORA believes this is reasonable because RTC did not make any effort to minimize the potential for franchise impact claims by aggressively pursuing competitive depreciation lives for technology accounts as Pacific and Verizon have. RTC has not changed its depreciation rates since 1994. Pacific and Verizon have aggressively pursued shorter lives and technical updates since 1990. RTC should also have done this.

ORA also recommends that, in return for elimination of depreciation filings, RTC should be required to do the following:

· File a final depreciation study using economic lives for review and approval by the Commission; and

· Provide an annual depreciation report to ORA by June 30 of each year setting forth the data on depreciation rates, depreciation lives used, reserve balances and any other depreciation parameters used.

ORA expects that its proposed final depreciation review will not increase depreciation rates. However, if it results in higher rates, RTC should not be granted a revenue increase because the increase would be due to RTC's failure to update depreciation rates in a timely manner. If the result is a significant decrease, RTC should be required to reduce its rates.

ORA points out that RTC's high depreciation rates have resulted in high depreciation expenses and, as a result, lower sharable earnings. Unless RTC changes its depreciation rates, sharable earnings will be reduced.

ORA says that Pacific, Verizon and CTC have voluntarily agreed to provide an annual depreciation report to ORA. In Citizen's case, the report is part of a settlement agreement adopted by the Commission. ORA believes that such reports are important tools for monitoring depreciation rates.

C. Discussion

The parties agree that depreciation reviews should be eliminated. Therefore, we will eliminate them. Regarding franchise impacts, elimination will foreclose recovery of franchise impacts for future investments and depreciation. Recovery of franchise impacts for past investments and depreciation is best addressed when and if RTC files such a request. We will not require a final depreciation review because ORA has not shown that such a review is necessary to protect ratepayers. In particular, ORA has not shown that updated depreciation rates would have any effect on sharable earnings. In fact, some of ORA's arguments suggest that, for certain accounts, RTC's depreciation expense has been lower than would be expected. We also decline to mandate annual depreciation reports, as ORA has not demonstrated that the benefit outweighs the burden. However, we expect RTC to cooperate with ORA in providing information when requested.