8. Should Pacific Refund the $11.5 Million to its Ratepayers?

8.1. ORA's Position

ORA asserts that if the Commission terminates the EAS payments and thereby ends Pacific's financial obligation to Roseville, Pacific should be ordered to refund the $11.5 million to its ratepayers. According to ORA, the

$11.5 million must be returned to ratepayers because Pacific is currently collecting this amount through its rates. This implies that there is a cost to Pacific, and Pacific is authorized to recover its cost. Thus, if Pacific is no longer obligated to make EAS payments to Roseville, it should not be allowed to collect the $11.5 million annually through rates. Otherwise, there would be a windfall of $11.5 million to Pacific on an annual basis.

ORA states that refunding the EAS revenues to ratepayers is proper and consistent with the Commission's actions in the past. According to ORA, Pacific also had EAS agreements with Citizens and GTEC, (now Verizon), whereby Pacific provided a subsidy for EAS traffic. Recognizing that EAS agreements were only intended to be temporary and intended to be eliminated by 1997, the EAS agreements between Pacific and Citizens and between Pacific and GTEC were eliminated in 1997. The elimination of those EAS payments to the two LECs was reflected in Pacific's rates through a Z factor adjustment in its price cap filing.

Even though Pacific adjusted its rates to reflect the elimination of its EAS payments to Citizens and GTEC, Pacific asserts that it should not be required to adjust its rates in this proceeding. According to ORA, Pacific asserts that an adjustment cannot be done because an EAS cost change does not qualify for limited exogenous (LE) treatment.

ORA references D.98-10-026 in which the Commission streamlined Z-factor treatment by eliminating new Z factor adjustments and adopting a limited exogenous framework.¹¹ According to ORA, the Commission held that only two types of cost decreases or increases qualify for LE adjustments: (1) matters mandated by the Commission and (2) changes between federal and state jurisdictions. Pacific's witness Borsodi states that EAS does not qualify as an LE-factor because "the termination of Pacific's obligation to pay the EAS payments to Roseville is not a Commission mandated cost change." (Exh. 16 at 5, Borsodi for Pacific.) Furthermore, Borsodi states "the Commission does not need to issue a decision ordering Pacific to end the payments." (Ibid.) ORA states that Borsodi's characterization of the STA and his interpretation of the Commission's LE framework are flawed and plainly incorrect.

First, says ORA, the STA states that Pacific and Roseville agree to use their best efforts to negotiate a permanent EAS arrangement. However, if they fail to reach a new EAS arrangement by 1997, either party or the parties may jointly request the Commission to establish a permanent EAS arrangement. ORA does not dispute that the STA allows Pacific and Roseville to end the EAS payments, without the Commission's approval or intervention. However, in this case, the parties have been unable to reach a new agreement on their own. Hence, says ORA, Pacific's EAS obligation to Roseville still exists and this issue is now before the Commission for a resolution. Thus, concludes ORA, it would qualify as an LE factor.

ORA states there are other available options, in addition to the LE-factor option, that the Commission can use to order Pacific to make the EAS cost adjustment. D.98-10-026 allows the Commission to address new rate adjustments such as EAS outside of the LE realm. The decision states as follows:

[N]ot every Commission-mandated cost change will necessarily be reflected in rates, unless considered by the Commission at the time the program or event causing the cost change is authorized, and the change is therein approved for LE factor recovery. Moreover, in considering whether the cost will be allowed, we will consider whether the cost is unique to Pacific...or is a cost generally borne uniformly by all carriers in the industry. (D.98-10-026 at 61-62.)

According to ORA, by this statement the Commission correctly recognized that there may arise circumstances where a cost adjustment will be necessary. The $11.5 million EAS cost is clearly unique to Pacific because only Pacific's ratepayers are assessed the cost of EAS payments to Roseville. The potential of double recovery should be avoided, says ORA. ORA concludes that even if the Commission finds that the EAS cost change does not meet the LE criteria, the Commission could still order revenue adjustments resulting from the EAS arrangement pursuant to D.98-10-026.

ORA rejects Pacific's allegation that it has refunded more than it received for EAS in the start-up revenue requirement. In January 2000, ORA and Pacific met and at that time Pacific provided an analysis of its rate changes associated with EAS payments. (See Exh. 18.) According to that analysis, Pacific stated that its startup revenue requirement for EAS was $32.8 million. Months later, Pacific revised its startup revenue requirement for EAS downward to $25.155 million. According to ORA, Pacific's witness Borsodi could not provide an explanation of why the start-up revenue amount had changed, but indicated the accounting people who prepared the information had not consulted with him on the development of the startup number.¹² ORA points out that Borsodi was present at the January 2000 meeting and did not dispute the $32.8 million amount at that time. ¹³ ORA concludes it is questionable whether $25.155 million is the correct startup amount as Pacific alleges or $32.8 million or some other figure.

Pacific's growth in local service revenues also undermines its assertion that it has refunded more than what it has received for EAS. From 1989 to 1999, Pacific's local service revenues increased 61%. Pacific's number of access lines also increased 34.3% over the same period. (Exh. 25.) Thus, even though Pacific alleges that it has refunded more money than it has received, that allegation is questionable at best, states ORA.

8.2. Pacific's Position

Pacific refutes ORA's position that Pacific should return the $11.5 million to ratepayers. According to Pacific, the adjustments that were made to Pacific's rates in the past, when EAS payments were terminated, were made under the Z-factor mechanism of NRF, before the Commission eliminated Z-factors in D.98-10-026. The Z-factor mechanism was replaced by the LE factor mechanism which allows adjustments for cost increases or decreases resulting from: (1) matters mandated by the Commission; and (2) changes in total intrastate cost recovery resulting from changes between federal and state jurisdictions. Further, states Pacific, in D.98-10-026, the Commission stated that:

Z-factor recovery shall be continued until fully implemented only for the following adjustments: (1) $200 to $500 capital to expense shift, (2) merger refund authorized in D.97-03-067, (3) gain on sale of land, (4) other billing and collections jurisdictional cost shift, (5) results of Order Instituting Investigation 92-03-052 regarding property taxes, (6) a $99.5 million annual reduction in Pacific's rates for post retirement benefits other than pensions (PBOP) and a $24.025 million annual reduction in GTE's rates for PBOPs, and (7) a $12.656 million reduction in GTE's customer notification and education program costs. (D.98-10-026 at 93.)

Pacific asserts that EAS payments are a subset of intraLATA toll pooling costs. The $19.3 million and $7 million in refunds to which ORA's witness Jarjoura refers were a subset of a total reduction of $36.9 million associated with termination of intraLATA toll pooling payments in Resolution T-15976. In that Resolution, the Commission classified the rate reduction as a Z-factor.

Today, says Pacific, the Commission no longer recognizes changes in intraLATA toll pooling arrangements for Z-factor or LE-factor treatment. The Commission has explicitly discontinued the Z-factor mechanism and has specifically excluded changes in IntraLATA Toll Pooling costs from LE-factor treatment. In D.98-10-026 the Commission stated:

Our elimination of new Z-factor adjustments means we will no longer authorize recovery for exogenous cost changes, such as Commission-adopted Financial Accounting Standards Board accounting changes, changes in intraLATA toll pooling, or changes in federal or state tax laws. (Id. at 61.)

Furthermore, Pacific states it proved that Pacific refunded more than it received in the start-up revenues established in NRF so a further refund is not warranted. Pacific provided the Commission with the EAS payments made to each company for the period 1989 to 1999 and the costs included in the startup revenue requirement. Simple calculations provide a reasonable demonstration that Pacific has paid substantially more than the costs reflected in the startup revenue requirement. According to Pacific, EAS payments to Roseville were $8.1 million and $8.6 million for 1990 and 1991, respectively, and $11.5 million in 1992 and thereafter. In contrast, a reasonable estimate of the costs in the start-up revenue requirement for EAS payments to Roseville is less than $3.0 million annually.¹⁴ In other words, says Pacific, it has been paying Roseville between $5 million and $8.5 million more annually over the last ten years than was reflected in the startup revenue requirement. Over the 10-year period, EAS payments to Roseville have been about $80 million more than the EAS costs included in the startup revenue requirement.¹⁵

Pacific reviewed total EAS payments made by Pacific to all companies that were eligible to receive such payments since 1989 and compared that to total EAS costs in the start-up revenue requirement, net of rate adjustments made by Pacific in annual price cap filings, and found the shortfall is more severe. According to Pacific, its total EAS costs reflected in the startup revenue requirement were $25.155 million annually. Rate reductions that were ordered in ensuing annual price cap resolutions reduced rates by an annual amount of $27.026 million. Therefore, Pacific states it has already refunded approximately $1.9 million more in annual rate reductions than what was included in the start-up revenue requirement. Over the same period of 1990-1999, actual EAS payments significantly exceeded the costs included in the start-up revenue requirement. According to Pacific, the total difference over the 10-year period has been over $131.0 million.¹⁶

Pacific states that ORA's opinion that Pacific should refund EAS payments even if such payments are not reflected in Pacific's rates should likewise be disregarded. ORA's original position, as stated in its prehearing conference statement, was that Pacific should only be required to refund EAS payments if these payments were reflected in Pacific's rates.¹⁷ Pacific asserts that because Pacific has shown that these payments are not in rates, ORA's story has changed. Pacific states that requiring it to refund money it is not collecting in rates amounts to a taking.

In its Reply Brief, Pacific rebuts ORA's argument that since Pacific refunded EAS payments previously, it should do so now. This ignores the fact that D.98-10-026 ordered that these cost charges should no longer be recognized as Z-factor or LE-factor adjustments. The refunds that ORA cites were all prior to the issuance of D. 98-10-026. As Pacific's witness testified, Pacific was not even aware until after the decision was issued that it had refunded more than it had ever collected in the start-up NRF adjustments. Pacific asserts the Commission should follow its directive in D.98-10-026 and find that ORA's request for an LE-factor is unsupportable.

Pacific refutes ORA's position that because Pacific and Roseville could not reach a new agreement on their own, Commission intervention is necessary, and therefore the $11.5 million qualifies as an LE-factor. Pacific states ORA relies on an incorrect fact to come to its conclusion. Recently, Roseville and Pacific reached a new agreement on a permanent EAS arrangement, which has been filed in this proceeding.

Also, states Pacific, ORA's quote from D.98-10-026 means the opposite of what ORA claims. ORA cites the following language from the decision:

[N]ot every Commission-mandated cost change will necessarily be reflected in rates, unless considered by the Commission at the time the program or event causing the cost change is authorized, and the change is therein approved for LE factor recovery. Moreover, in considering whether the cost will be allowed, we will consider whether the cost is unique to Pacific...or is a cost generally borne uniformly by all carriers in the industry. (Id. at 61-62.)

ORA interprets this statement to conclude that the Commission "recognizes that there may arise circumstances wherein a cost adjustment will be necessary...[t]hus...the Commission could still order revenue adjustments resulting from the EAS arrangement pursuant to D.98-10-026. (ORA's Opening Brief at 15.) According to Pacific, ORA's interpretation does not make sense. The plain language of the citation clearly intends to limit LE factors potentially even

beyond what the criteria for LE-factor treatment might indicate, not to expand LE-factor opportunities or imply discretion by the Commission. In fact, the paragraph from which ORA's cite was taken explains the Commission's intent when it states "[t]o further streamline the process, we limit rate changes for Commission-mandated cost changes." (D. 98-10-026 at 61.) The Commission also states, "our elimination of the Z-factor mechanism, and replacement with an LE-factor mechanism, is essentially a further narrowing and simplification of the existing process."

8.3. Discussion

The resolution of this issue turns on parties' varying interpretations of D.98-10-026. We will clarify our intent in that decision, but to place our discussion in context, we must first summarize the history of exogenous factors in NRF. When we first adopted the NRF framework for Pacific in D.89-10-031, we included changes in IntraLATA Toll Pooling as one of the initial Z-factors:

As a starting point, we accept the following factors: changes in federal and state tax laws to the extent they affect the local exchange carriers disproportionately, mandated jurisdictional separations, changes to intraLATA toll pooling arrangements or accounting procedures adopted by this Commission, changes in regulatory amortizations such as expensing of station connections, and reflection of tax benefits resulting from premature retirements of high coupon bonds pursuant to D.88-12-094.¹⁸

In other words, changes in intraLATA toll pooling arrangements, of which EAS is a subset, was clearly delineated as an allowable exogenous factor. And in fact, as ORA points out, when Pacific ended its EAS agreements with Citizens and GTEC in 1997, the elimination of the EAS payments was reflected in Pacific's rates through a Z factor adjustment in Pacific's annual price cap filing.

At the end of 1998, after we approved Z-factor treatment for those EAS adjustments, we issued D.98-10-026. That decision in the Third Triennial Review of our NRF program for Pacific & GTEC made substantial changes in the treatment of exogenous factors. We eliminated consideration of any new Z-factor adjustments. (D.98-10-026 at 60.) We also examined all existing Z-factors, including intraLATA toll pooling, and determined which Z-factors should be phased out over time. We developed a list of seven items which would be allowed continued Z-factor treatment on a limited time basis. IntraLATA toll pooling was not included on that list of allowable Z-factors. To the contrary, we specifically excluded changes in intraLATA toll pooling, as Pacific cited above, as follows:

Our elimination of new Z-factor adjustments means we will no longer authorize recovery for exogenous cost changes, such as Commission-adopted Financial Accounting Standards Board accounting changes, changes in intraLATA toll pooling, or changes in federal or state tax laws. (Id. at 61.)

In other words, we made it clear that intraLATA toll pooling would no longer be included among allowable Z-factor adjustments.

According to ORA, while we eliminated intraLATA toll pooling as a Z-factor, the EAS adjustment could be treated as an LE factor, under the new

criteria adopted in D.98-10-026. In order to clarify our intent in that decision, we need to review the entire relevant portion of the text, including the portion cited above:

Our elimination of new Z-factor adjustments means we will no longer authorize recovery for exogenous cost changes, such as Commission-adopted Financial Accounting Standards Board accounting changes, changes in intraLATA toll pooling, or changes in federal or state tax laws. We will, however, allow continuation of a streamlined process for requests in two narrow areas: requests for recovery of cost increases or decreases resulting from (1) matters mandated by the Commission and (2) changes in total intrastate cost recovery resulting from changes between federal and state jurisdictions. (Ibid.)

ORA asserts the EAS payment should be included as an LE-factor because it fits the criteria of number (1) "matters mandated by the Commission." We agree that we have the authority to mandate the end of the EAS payment from Pacific to Roseville, and are doing so in this order. However, ORA's interpretation of our intent is not correct. As cited above, we eliminated recovery for exogenous cost changes for intraLATA toll pooling for Pacific and GTEC. Our former Z-factor and the LE-factor we adopted in D.98-10-026 both relate to "exogenous cost changes" so we clearly intended that intraLATA toll pooling would be exempt from either Z-factor or LE-factor treatment when we said that we would not authorize recovery for exogenous cost changes for changes in intraLATA toll pooling.

ORA cites a paragraph from D.98-10-026 which ORA interprets as allowing the Commission to order revenue adjustments, other than through an LE-factor. ORA has taken that particular paragraph out of context. Following is that paragraph with the leading two sentences included to give the proper context to our words:

We allow these two exceptions [the two LE factor exceptions] because they remain potentially significant exogenous events outside utility management control. To further streamline the process, we limit rate changes for Commission-mandated cost changes (either increases or decreases) to only those costs for which an LE factor adjustment is authorized in the underlying Commission decision. That is, not every Commission-mandated cost change will necessarily be reflected in rates, unless considered by the Commission at the time the program or event causing the cost change is authorized, and the change is therein approved for LE factor recovery. Moreover, in considering whether the cost will be allowed, we will consider whether the cost is unique to Pacific and/or GTE, or is a cost generally borne uniformly by all carriers in the industry. (Id. at 61-62.)

The language ORA cited must be reviewed in the context of our adopted rules for the implementation of the LE-factor. That entire paragraph pertains to LE-factors, and ORA's assertion that the second part, taken alone, means that the Commission will address rate changes outside of the LE context is without merit, and is not supported by the plain language of the decision. The entire paragraph deals with treatment of LE factor adjustments.

ORA's proposal that Pacific refund the $11.5 million to its ratepayers is rejected, as it is inconsistent with our directive in D.98-10-026. Therefore, the analysis of whether or not Pacific has paid more than its start-up revenue requirement is moot, and will not be addressed.