VI. Basic Residential Rates: Impact of CHCF-B

Currently, the Commission generally sets telecommunications rates for any single carrier based on the state-wide costs associated with the carrier's operations. While no statute requires a uniform state rate for basic residential service, California policy recognizes that telecommunications costs vary by region, and the state has used geographically averaged rates and created programs to "reduce" this "disparity in rates."⁵³²

Even when we continued to require geographically averaged rates, the Commission recognized the "merits of . . . the adoption of geographically deaveraged LEC retail rates" for quite some time.⁵³³ The Commission announced its intention to develop geographically unfettered rates as far back as ten years ago.⁵³⁴ This development, however, was stalled by a desire to first wait "until the appropriate pricing studies are concluded."⁵³⁵ With market competition in its infancy, the Commission supposed it would need to establish geographic areas, conduct cost studies in each area, and establish a price for the ILEC that offered retail service in each area. It is not surprising that the Commission never approved geographically unfettered prices, given the complexities of conducting cost and pricing studies that the Commission then deemed necessary.

The first major policy issue we address today is whether we now should permit geographically unfettered pricing for telecommunications services. If adopted wholesale, the policy reform would permit ILECs to engage in unfettered pricing of all services in each geographic region that it defines. Expressed in the record are many intermediate positions that would allow unfettered pricing for specific services, such as business services, or in particular places, such as on lines not receiving a geographically-based CHCF-B subsidy. Consequently, our forward-looking policy must determine both whether and to what extent to permit geographically unfettered prices.

A. Position of Parties

AT&T, the largest ILEC, supports the complete elimination of all requirements controlling the prices of telecommunications services.⁵³⁶ AT&T would do away with, among other regulations, price rules that would require geographically averaged pricing.⁵³⁷ AT&T characterizes its proposed policy reform as "full pricing flexibility."⁵³⁸ In AT&T's view, lack of this full pricing flexibility prevents "efficient facilities-based competition,"⁵³⁹ and its proposed reform would more closely align "costs and prices."⁵⁴⁰

Verizon joins AT&T in its support of geographically unfettered prices. Verizon states that under its proposal, "[f]ull geographic deaveraging would be permitted."⁵⁴¹

Frontier endorses a similar policy reform. The mid-sized ILEC argues that "[p]ricing flexibility for non-basic services should include the ability to deaverage prices geographically."⁵⁴² Frontier points to current pricing practices in support of this proposal:

Costs are not uniform throughout all of California or over all of Frontier's large and diverse service area, and there is no reason for prices for competitive services to be the same by regulatory fiat. The record is clear that California already has deaveraged prices for telecommunications services depending upon the service provider that a customer is either assigned to or chooses. . . . Customers have already accepted[ed] deaveraging, and would be prepared to accept a more market-based, cost-based version of deaveraging in the future, should companies elect or be compelled by competition to move in that direction."⁵⁴³

According to Frontier, its proposed policy reform would merely build upon other geographically-based telecommunications prices already allowed in California.

DRA supports geographically unfettered pricing, but only with certain conditions. DRA would permit only "downward" price revisions - meaning price decreases but no price increases - and only after the Commission completes an investigation of "the high-cost fund subsidy levels."⁵⁴⁴ DRA contends that "it would be fundamentally inconsistent with the move toward a more uniform framework and would be unfair to potential competitors to allow the ILECs to deaverage basic service rates while they are still receiving subsidies to maintain affordable basic service rates in high-cost areas"⁵⁴⁵:

Competitive issues aside, allowing upward deaveraging in combination with CHCF-B subsidies would also pervert the very purpose of providing high-cost funds and would likely harm those ratepayers in outlying areas who are far less likely to have access to competitive options. Moreover, given that small ILEC Lifeline service rates are keyed to SBC's existing basic service prices, allowing SBC to increase its basic service prices for some (but not all) residential customers would complicate the determination of permissible Lifeline service rates outside SBC's service territory.⁵⁴⁶

Consequently, DRA, at this time, opposes any grant of authority to increase prices for basic rates, which in turn would limit the ILECs' ability to have non-geographically averaged rates other than through downward price movements.

Cox, a competitor not subject to geographic pricing limitations, likewise opposes geographically unfettered pricing for ILECs. Cox claims that price freezes are needed to prevent "ILECs from engaging in anticompetitive pricing":

The ILECs' insistence on downward pricing flexibility for subsidized services, along with the right to engage in geographical deaveraging for bundles and promotions (as AT&T and Verizon have proposed), discloses their goals. They intend to use the high-cost subsidies to fund their targeted price reductions, offering lower prices on subsidized services where they face the most inroads from competitive entrants. Customers who have no competitive alternatives will continue to see higher prices, which (combined with the [C]HCF-B funds) will help the ILECs with their continued efforts to block competition from every angle.⁵⁴⁷

Given these concerns, Cox concludes that it is "absolutely essential that the Commission resolve the issue of high-cost subsidies before it allows the ILECs to have downward pricing flexibility."⁵⁴⁸ Cox asserts that the Commission, in particular, should "make certain that it has completed its analysis of the subsidy issues" before permitting downward pricing flexibility for basic residential service and geographically targeted promotions.⁵⁴⁹

TURN lends further support to the argument that "the Commission should deny authority for geographic deaveraging at this time."⁵⁵⁰ TURN contends that there is "insufficient evidence in the record to allow this Commission to conclude that rates will remain `just and reasonable' if it adopts any of the deaveraging proposals. . . . The `record' on deaveraging in this proceeding, including all comments, briefs and workshop transcripts, amounts to perhaps 5 double spaced pages, if that."⁵⁵¹ TURN finds the arguments made by AT&T, Frontier, and Verizon unpersuasive.

B. Discussion: Public Policy Programs Make Geographically Unfettered Pricing Inappropriate in Certain High-Cost Areas

As described in Section III above, federal and state statutes require that our regulations should promote competition in the telecommunications marketplace; use competitively and technologically neutral policies to encourage development of a wide choice of new technologies and services; and ensure continued support for social policies embodied in the statutes. This section applies this statutory guidance and finds that the current policy of geographically averaged prices fails to meet the major statutory goals for this proceeding.

First, the current policy of geographically averaged prices is inconsistent with a competitive marketplace. This policy made more sense in a past monopoly era, where universal service subsidies were applied to the monopolist's high-cost areas. As AT&T correctly observes, only a policy that permits prices to move towards costs is consistent with "efficient facilities-based competition."⁵⁵² A requirement of geographically averaged prices could lead to the provision of services by high-costing but subsidized technologies, while discouraging service by low-costing but unsubsidized services. As an example, in many rural areas, it may prove less expensive to provide dial tone telephone service via wireless technologies than by subsidizing the construction of long copper wire traditional telephone service connections.

Second, the policy of geographically averaged prices is not applied in a technologically and competitively neutral fashion. The policy requirement only applies to California ILECs, and not to cable carriers, wireless carriers, or the new VoIP companies. Consequently, the policy puts the traditional landline telephone carriers subject to this requirement at a significant disadvantage vis-à-vis their competitors. For the ILECs, the policy mandating geographically averaged prices requires that they price communications services above costs in urban areas where traffic and population densities cause costs to be low; at the same time, ILECs must provide services at prices that are below costs in areas where low densities lead to high service costs. The policy of geographically averaged prices effectively prevents ILECs from competing with other providers on a level playing field. As a result, the policy discourages, rather than encourages, fair competition in the telecommunications marketplace.

Finally, when considering reforms to price regulation, we cannot overlook our third policy goal: to continue to support social policies embodied in statutes. The requirement of uniform prices across geographic areas currently is inextricably linked to our CHCF-B program, which acts to subsidize service in ILECs' high-cost areas. Surcharges placed on both wireless and wireline telephone bills are used to subsidize wireline services provided by carriers of last resort (COLRs) that provide services in areas where costs exceed $20.30 for basic residential service. VoIP consumers, under our current rules, do not have to pay the surcharge. Offsetting competitive disadvantages of price controls, ILECs receive approximately $450 million in CHCF-B subsidies for their provision of residential wireline telephone services in areas where costs exceed the $20.30 cutoff level.⁵⁵³ The policy of geographically averaged prices, in conjunction with the CHCF-B program, supports the continued affordability of telecommunications services in high-cost areas where the costs of providing services exceed the prices charged. The program enables connections to our landline telephone system at artificially low rates for important universal service reasons. We believe it would be contrary to the Legislature's intent if we no longer required CHCF-B subsidized services to be offered at geographically averaged prices.

At the same time, however, we recognize that even the statute creating CHCF-B has its limits. Pursuant to Public Utilities Code § 739.3, we set a rate that ensures high-cost areas are sufficiently subsidized through CHCF-B. Offering high-cost services at a price lower than the mandated below-cost rate infringes upon our first policy goal, to encourage reliance on a competitive marketplace. While we do not share Cox's concern with anticompetitive pricing,⁵⁵⁴ we agree that ILECs should not be able to manipulate markets by offering special promotions that price CHCF-B subsidized services even further below the already below-cost rate specified by the Commission. Thus, we find that both a price floor and a price ceiling are necessary to ensure appropriate pricing for CHCF-B subsidized services.

We hold that no other statutory social policy applies to the question of whether telecommunications services should be geographically unfettered. Neither CHCF-B nor any other social policy program is directly implicated by unsubsidized services.

C. Discussion: Market Conditions Indicate Geographically Unfettered Pricing Is a Reasonable Policy in the Absence of CHCF-B Subsidies

Given the absence of a statutory constraint, we now turn to whether market conditions make unfettered pricing a reasonable policy for services that are not subsidized by CHCF-B. This review requires us to consider pricing power of the ILECs in this proceeding.

As we established in Section V, the evidentiary record in this proceeding demonstrates that current competition or the threat of market entry exists throughout the ILECs' service territories. We find that FCC-mandated unbundling policies; the required provision of stand-alone DSL service by Verizon and AT&T; and substantial cross-platform competition sufficiently restrain incumbents' pricing power. Market conditions do not present an obstacle to usage of unfettered pricing in the absence of subsidies imposed to promote specific social policies.

Indeed, allowing geographically unfettered pricing for telecommunications services not supported by CHCF-B may improve market competition and the supply of telecommunications services in rural areas. Our current policy of requiring geographically averaged pricing may encourage an oversupply of wireline services in high-cost areas - that is, the geographic averaging requirement may promote use of high-cost services when an efficient market might provide similar services with a lower-cost technology (such as wireless or VoIP services).

In conclusion, we find that neither statutory directives nor market conditions warrant continuation of our geographically averaged pricing policy for services that are not subsidized by CHCF-B. We, therefore, remove the geographic averaging requirement for all services other than CHCF-B subsidized basic residential service. We also lift this requirement for all bundled services that do not include CHCF-B subsidized basic residential service.

We, however, hold that pricing restrictions remain necessary should the basic residential services rate be supported by CHCF-B subsidies. CHCF-B subsidies are market-distorting, and thus broader pricing freedoms requested by the ILECs are imprudent. Thus, we order 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. By adopting this price freeze, we effectively create both a price floor and a price ceiling for basic residential service rates that are supported by CHCF-B subsidies.

⁵³² § 739.3 states that the purpose of the program is "to reduce any disparity in rates charged by those companies" - namely, the seventeen small independent telecommunications carriers that provide service in California. Even this policy approach, however, has exceptions. Rates for basic service vary substantially across carriers. Verizon has two basic rates depending on exchange, and within AT&T service territories, a proliferation of EAS services create a disparity in the "basic rate."

⁵³³ Order Instituting Rulemaking on the Commission's Own Motion Into Competition for Local Exchange Service, D.96-03-020, 65 CPUC2d 156 (1996), 1996 Cal. PUC LEXIS 257, 29-30.

⁵³⁴ Id.

⁵³⁵ Id.

⁵³⁶ Pacific Bell Opening Brief at 58 (stating that "market forces must be allowed to operate unimpeded by outmoded regulatory restrictions on prices, promotions and introducing new services").

⁵³⁷ Id. (declaring that "carriers should be free to offer geographically deaveraged prices").

⁵³⁸ Id. at 58-59.

⁵³⁹ Pacific Bell Reply Comments at 41.

⁵⁴⁰ Pacific Bell Reply Brief at 48-49.

⁵⁴¹ Verizon Opening Brief at 3.

⁵⁴² Citizens Opening Brief at 21.

⁵⁴³ Id.

⁵⁴⁴ DRA Opening Brief at 6 n. 5. As mentioned previously, the Commission has initiated a rulemaking on CHCF-B in R.06-05-028.

⁵⁴⁵ DRA is referencing the fact that the large ILECs receive CHCF-B subsidies for high-cost areas.

⁵⁴⁶ Reply Brief of the Division of Ratepayer Advocates at 25 (March 24, 2006) (hereinafter "DRA Reply Brief"). Note SBC is now AT&T.

⁵⁴⁷ Cox Opening Brief at 19.

⁵⁴⁸ Id.

⁵⁴⁹ Id. at 20.

⁵⁵⁰ Reply Brief of the Utility Reform Network at 40 (March 24, 2006) (hereinafter "TURN Reply Brief").

⁵⁵¹ TURN Reply Brief at 44.

⁵⁵² Pacific Bell Reply Comments at 41.

⁵⁵³ CPUC Resolution T-16883, adopted October 28, 2004.

⁵⁵⁴ Predatory pricing is unlawful, and remains so whether or not the Commission permits geographically unfettered pricing. A company engages in predatory pricing when it sets the price of its services or goods very low, in order to eliminate its competitors and prevent new competitors from entering into the marketplace. Also the existence of the CHCF-B subsidies does not affect the economic rewards or costs that arise from a policy of predatory pricing. These subsidies should only allow a carrier to recover actual costs it incurs while providing below-cost services; all carriers providing service receive them at the same rate. Thus, we see no economic link by which the CHCF-B transfers encourage predatory pricing.