VI. Interim Rates for Unbundled Switching

In their motion for interim relief, Joint Applicants request that the Commission adopt an interim UNE switching rate equivalent to one of the two alternative switching rates that SBC has proposed for its Illinois affiliate, SBC-Ameritech. Specifically, Joint Applicants propose that the Commission set interim rates equivalent to either of the options shown below.

Table 1

Joint Applicants base their request on the contention that current switching prices are based on outdated 1994 to 1996 data. According to Joint Applicants, Pacific's own publicly available data reveals that certain switching costs have decreased significantly since that time.37 Further, Joint Applicants highlight two of Pacific's admissions to support an interim rate on par with Illinois. First, Pacific admits it buys switches under an SBC-wide switching contract. (Kamstra Declaration, 4/20/01, para. 6.) Second, Pacific has stated that it can obtain switching prices that are as favorable as, or more favorable than those that its affiliates in Illinois and Michigan receive. (Joint Applicants' Reply Comments, 9/7/01, p. 5, citing Pacific's response to discovery request No. 118.) Given these statements by Pacific, Joint Applicants claim there is no basis for assuming that Pacific's forward-looking switching costs exceed the costs of SBC-Ameritech for Illinois.

Joint Applicants justify the application of an Illinois rate by comparing the average lines per switch for Pacific with SBC-Ameritech in Illinois. Joint Applicants contend that Illinois is the closest proxy to California for local switching operations in SBC's service territory. Based on 2000 ARMIS data, Pacific has the highest average number of lines per switch, with Illinois as the next highest average. (Murray Declaration, 9/7/01, p. 5.) Joint Applicants also note that Pacific's current switching prices are as much as 252% higher than the prices SBC-Ameritech has proposed for Illinois and 207% higher than the prices the Michigan Public Service Commission recently adopted for SBC's affiliate in that state. (Motion for Interim Relief, 8/20/01, p. 8.) Joint Applicants maintain that this difference in rates is unsupportable given the similarities in switch density of the two states, shown by average lines per switch, and the admissions of SBC-wide purchasing.

To further support their request, Joint Applicants contend that the switching costs calculated by HAI confirm that switching prices should be as low as, or lower than, the proposed Illinois rates. Joint Applicants state that using Pacific's own public information about costs in 2000, HAI produces a total local switching cost per line of $2.82 per month. (Mercer Testimony, 8/20, p. 7; Mercer Declaration, 11/9/01, p. 3, footnote 10.) Based on this output of the HAI model, Joint Applicants maintain that either of the rate options proposed in Illinois would lead to conservative interim switching prices. In addition, the Joint Applicants contend that the FCC's Synthesis Model also produces forward-looking switching costs that support their interim relief request. (Klick Testimony, 8/20/01, p. 29-30.)

In the September 28 ruling, the Assigned Commissioner and ALJ stated a concern that the proposed interim rates from Illinois differ dramatically in price structure from Pacific's current rates. The ruling required Joint Applicants to reformulate their request to entail a percentage reduction from current switching rates using the same rate structure as is currently in use for Pacific. In their amended filing, Joint Applicants reformulated the price structure as requested, but continue to recommend that the Commission adopt interim unbundled local switching and tandem rates no higher than SBC-Ameritech's proposed rates for Illinois.

Joint Applicants derived a method to take the results of their switching analysis and convert it Pacific's current rate structure. Their proposal provides Pacific with the same compensation for an average end-user for local switching that SBC would receive for service provided to an average Illinois end-user based on the proposed Illinois prices. This reformulated request entails a 69.4% reduction from current local switching prices and a 79% reduction from current tandem switching rates.38 Once again, the Joint Applicants rely on the output of the HAI model to support their request for an interim rate equivalent to the rates proposed by SBC-Ameritech in Illinois.

Joint Applicants maintain that this across the board 69.4% reduction for local switching may inadvertently result in a large true-up once final rates are adopted. Joint Applicants ask that the Commission consider minimizing the expected true-up by simplifying the current UNE switching rate structure for interim pricing. Joint Applicants provide two alternatives to the across the board 69.4% discount that they believe will result in a smaller true-up. The first alternative entails simplifying the distinctions between call types. Joint Applicants suggest that the Commission should remove the distinction between call types because Pacific itself has proposed this simplification when it proposed a discount for switching rates in the 271 proceeding. Specifically, Joint Applicants ask that, identical to Pacific's Section 271 proposal, the Commission eliminate the distinction in rates between intraoffice calls and originating interoffice calls.

Joint Applicants' second alternative switching price structure takes this simplification of call types and also removes any separate vertical feature charges. Again, this mimics Pacific's own proposal in the Section 271 proceeding. This would result in a discount of 63.2% for switching, and no charge for features. Joint Applicants contend that this second alternative proposal will likely lead to a smaller true up than the 69.4% across the board discount once final UNE switching rates are adopted.

Pacific responds to this amended proposal by stating that Joint Applicants have not demonstrated that Pacific's switching costs have fallen by anything approximating 69.4% or that the prices SBC-Ameritech has proposed for Illinois are a reasonable surrogate for Pacific's switching costs. Pacific contends that Joint Applicants have failed to provide factual support for lower switch prices, more efficient switch maintenance practices or any new technology. Further, Pacific contends that Joint Applicants have made no showing that Illinois costs are relevant or determinative of Pacific's costs.

First, Pacific disputes any attempt by Joint Applicants to imply that the proposed price for unbundled switching in Illinois is sufficient to recover all of Pacific's switching costs. Pacific's witness Dr. Palmer explains that SBC-Ameritech disagrees with a number of aspects of the Illinois switching cost study and is appealing it. Further, Pacific contends that Joint Applicants have not established that California and Illinois have any similarity on a number of factors critical to switching prices including fill factors, cost of capital, cost of money, depreciation rates, labor rates, tax rates, and switch types. According to Pacific, the Joint Applicants' proposal to use Illinois prices is based solely on claims regarding switching investment and does not consider other factors that determine the UNE rate for unbundled switching.

Second, Pacific provides a comparison of the relative cost results of the FCC Synthesis Model for California and Illinois and uses this comparison to dispute the Joint Applicants' proposal to use Illinois switching rates.39 Based on its own run of the FCC's Synthesis Model, Pacific's contends that the Synthesis Model produces significantly higher end office usage and port costs for California than for Illinois and for other states where the incumbent local carrier has received approval under Section 271 to provide in-region long distance service.

Finally, Pacific notes that while Joint Applicants use a trend analysis using the HAI model to propose an interim loop rate, they do not use this same trend analysis to support an interim switching rate. According to Pacific, Joint Applicants performed the same trend analysis for switching costs and the results of that trend analysis do not justify the deep discount to Illinois rates that the Joint Applicants now propose. (Pacific Switching Comments, 10/30/01, p. 13.) According to Pacific, a trend analysis for switching suggests that local switching costs have fallen only 6% compared to the 69.4% reduction requested by Joint Applicants. (Id.)

We begin by noting that public data shows substantial declines in per line and per minute of use switching costs since we last adopted UNE switching prices in D.99-11-050. Specifically, Joint Applicants analyzed ARMIS data that Pacific reported to the FCC for switch investments in California and found that:

· Pacific's booked switching investments per minutes of use declined 28% from 1994 to 1999. (Pitts Declaration, 2/20/01, p. 6.)

· Pacific's switch expenses per line dropped 23% from 1994 to 1999 and expenses per minute dropped 32% over the same period. (Murray Declaration, 2/20/01, p. 4.)

· Pacific's support investments for unbundled switching, including the cost of computers and related equipment, declined 15% from 1994 to 1999. (Id., p. 7.)

· Pacific's ARMIS data for 2000 shows a continued decline in switch investments and switch expenses per minute of use. Specifically, Pacific reported a 26.5% decline in switching expense and a 51% decline in switching expense per DEM from 1994 to 2000. (Klick Declaration, 11/9/01, para. 18-19.)

We find that this publicly reported data supports the establishment of interim UNE switching rates while the Commission continues its review of updated cost models in this proceeding.

At the heart of the debate over which interim UNE switching rates to adopt is how SBC-Ameritech's proposed switching rates in Illinois compare to California costs. Pacific argues that Joint Applicants have not convincingly shown that critical cost factors that affect the UNE switching rate, such as labor rates and switch types, are the same across the two states. As we discussed in Section IV above, Pacific did not provide the cost material requested by Joint Applicants regarding Illinois. This material might have supported Pacific's claim that costs in the two states are not comparable, but it might also have shown major similarities in costs and cost drivers between the two states. However, Pacific chose not to make this information available to be introduced into the record of the proceeding, notwithstanding ALJ rulings compelling production of the documents.

As already discussed, because of Pacific's noncompliance with the ALJs' discovery rulings, we will deem the missing material to support the Joint Applicants' claim that switching rates in California should be lowered from current levels. For the same reason, we are disinclined to give substantial weight to Pacific's claims that there are significant differences that render the prices SBC-Ameritech proposed in Illinois lower than costs in California. As a result of Pacific's failure to produce the required information, the record has been deprived of what certainly would have been highly probative evidence of the comparability of switching costs between SBC's operations in Illinois and California. As Joint Applicants point out, Pacific's suggestions about factors that could lead switching costs to be higher in California than in Illinois could have been effectively analyzed had Pacific produced the required discovery. It would set a dangerous precedent to reward a party for its non-compliance with discovery rulings by according substantial weight to assertions that could have been supported by material that the party refused to produce.

Notwithstanding the gap in the record created by Pacific's non-compliance with the ALJs' discovery rulings, we find ample evidence to support Joint Applicants' contention that the SBC-Ameritech proposed switching prices either equal or exceed the appropriate cost-based rates in California.

Joint Applicants have presented public data that convincingly shows a substantial degree of uniformity across geographic regions in switching cost trends. (Klick Declaration, 11/9/01, pgs. 11-13.) Moreover, Pacific does not dispute that it buys switches under an SBC-wide switching contract. And Pacific has acknowledged that SBC is able to buy switches for use in California at prices that are equal to, or more favorable than, the prices at which it can buy switches for use in Illinois.

We also note that, for the two key cost drivers identified by the FCC, Joint Applicants have demonstrated characteristics indicating that switching costs in California are no higher than those in Illinois. With respect to average switch size, ARMIS data shows that Pacific has far more switched lines per switch than Illinois, which has 27 percent fewer lines per switch than California. With respect to the other factor, percentage of host vs. remote switches, the two states are nearly identical (Joint Applicants' Reply Comments, 11/9/01, p. 23; Klick Declaration, 11/9/01, pp. 15-16.)

Pacific claims that its run of the Synthesis Model does not support a switching rate discount. According to Pacific's analysis, the model indicates that California end office usage and port costs should be 23% and 19% higher than Illinois costs, respectively. (Pacific Bell Switching Comments, 10/30/01, p. 10.) Joint Applicants respond that Pacific has miscalculated and misconstrued the Synthesis Model results because Pacific's analysis fails to correct a substantial input error regarding usage volume. (Klick Declaration, 11/9/01, p. 5-6.) Moreover, Joint Applicants claim further flaws in Pacific's analysis from several factors including the fact that it relies on 1998 data rather than updated data for 2000. (Id., p. 7.)

Based on analysis performed by our staff, we agree that Pacific's run of the Synthesis Model is flawed because Pacific did not re-run the model with correct usage volumes.40 Rather, our staff corroborated the run of the Synthesis Model performed by Joint Applicants and its results do indeed show switching rates for California lower than those suggested by Pacific, and in line with the results described by Joint Applicants. (Klick Declaration, 11/9/01, pp. 5-6.)

In summary, the record supports Joint Applicants' position that switching costs in California are likely to be no higher than the rates that SBC itself proposed in Illinois. We will therefore adopt Joint Applicants' recommendation to apply SBC-Illinois' proposed switching rates as interim rates for California.

As explained above, Joint Applicants have shown that, if the SBC-Ameritech switching rate proposal in Illinois is reformulated based on the current switching rate structure in California, local switching rates would be reduced by 69.4% and tandem switching prices would fall by 79.3%. Rather than make any changes to the existing rate structure in this interim pricing decision, we will simply apply these percentage reductions to the appropriate existing switching rate elements, including the 31 vertical features listed in Appendix A of D.99-11-050. The resulting switching rates that we adopt are set forth in Appendix A.

37 Joint Applicants cite Pacific's testimony in the prior OANAD proceeding that the cost of new switches has been declining since 1993 at a rate of 8% per year. (D.99-11-050 at p. 172, fn. 152, as noted in Joint Applicants' Motion for Interim Relief, 8/20/01, p.7.) In addition, Joint Applicants explain that they ran HAI using SBC's publicly reported data for 1994 and 2000 for ARMIS expenses, ARMIS investment, and ARMIS demand data. (Klick Testimony, 8/20/01, p. 9.) 38 Joint Applicants calculate the 69.4% discount by first determining the total local switching revenue for an average per-line usage level based on the Illinois rate level. The result, $3.54, is then divided by an estimate of average current revenue from UNE local switching prices in California ($11.56). ($3.54/$11.56 = 30.6%, or a 69.4% discount). They perform a similar analysis to determine the tandem switching discount of 79%. (Amended Proposal of Joint Applicants, 10/15/01, p. 3-4.) 39 According to Pacific, the FCC has never used the USF cost model to determine rates for a particular unbundled network element and the model was not designed to perform such a task. Pacific explains that it makes this comparison only because Joint Applicants and others have suggested using the USF Model. (Pacific Switching Comments, 10/30/01, p. 9, footnote 19.) 40 According to a response to a data request from Commission staff, Pacific corrected the error noted by Joint Applicants and re-ran the Synthesis Model, obtaining similar results to Joint Applicants. (Pacific Bell Response to Data Request, 12/11/01.)

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