VII. Basic Residential Rates: Impact of LifeLine

California's basic residential telephone service rates are priced among the lowest in the country.⁵⁵⁵ For AT&T, basic residential flat rate service is $10.69 per month, while for Verizon, it is $16.85 or $17.25 per month, depending on the exchanges served.⁵⁵⁶ For SureWest, the tariffed rate for basic flat rate residential service is $18.90.⁵⁵⁷ For Frontier, the tariffed rate is $17.85.⁵⁵⁸ The rate for basic residential telephone service, therefore, varies by seventy-seven percent, depending on the carrier providing the telephone service. The Commission has found through its regulatory proceedings that all of these different rates qualify as "reasonable" rates for basic residential service.

These basic residential rates currently are set by Commission order. Carriers can neither decrease nor increase the rate charged for this service. In addition to the pricing issues that arise concerning the primary residential line, similar issues arise concerning secondary residential telephone lines.

A. Position of Parties

Most parties in this proceeding make a specific proposal concerning the pricing of basic residential services. No party calls for immediate upward pricing flexibility for primary residential lines or other services they consider basic, but there is significant variation among the various parties' proposals.

AT&T proposes "to cap temporarily the current rate for primary line basic residential service because of its relation to funding and administration of public policy programs."⁵⁵⁹ Although it maintains that market conditions "justify full pricing flexibility for all residential services,"⁵⁶⁰ AT&T proposes that this cap be in effect for "a transitional period ending not later than June 1, 2007, . . . to allow the public policy program issues to be resolved."⁵⁶¹ During this proposed transitional period, downward pricing flexibility would be allowed for all services, and no service beyond the primary line basic residential service would be capped.⁵⁶²

AT&T states that the funding mechanisms and administration of many public policy programs "would be affected by changes in [its] residential basic service rates."⁵⁶³ Specifically, AT&T notes that California's LifeLine rate is one-half of its current 1Flat Rate (1FR) rate⁵⁶⁴ and any change in the price of this service would affect both the LifeLine rate "for all consumers and the corresponding subsidy drawn by every carrier across the state."⁵⁶⁵ AT&T adds that "fluctuations in carrier draws would require corresponding changes in end-user surcharges."⁵⁶⁶

In contrast to AT&T, Verizon recommends that the Commission cap all residential service rates at current levels for three years beginning on the effective date of this decision.⁵⁶⁷ At the conclusion of the three-year transition period, the proposed caps would "automatically sunset without the need for further Commission action or litigation."⁵⁶⁸

Verizon suggests the Commission permit full downward flexibility for basic residential (and all other) telephone services.⁵⁶⁹ The ILEC argues that "eliminating price floors not only promotes . . . affordability of service, [but] it also advances a fundamental objective of competition itself, i.e., that firms not be discouraged from offering price decreases. Robust price competition is the essence of competition and should be encouraged in any Uniform Regulatory Framework."⁵⁷⁰ During the period in which it calls for basic rates to be capped, Verizon adds that the principle of "revenue neutrality" should apply. Under this principle, "price increases to `basic' services above the cap would require Commission approval, but would be permitted in response to Commission-mandated price decreases to any other price-regulated service, e. g., switched access charges."⁵⁷¹

Frontier states that "the hallmark of URF should be full upward and downward pricing flexibility for all ILEC services, subject to a limited transition period before the caps on primary line residential service are lifted."⁵⁷² The mid-sized ILEC concedes that caps on primary line residential services are warranted in the near term, due to the complex linkages between basic residential rates and public policy programs, specifically the "funding of the public policy subsidy programs."⁵⁷³ Frontier, however, requests that the Commission "institute a presumption that the caps be lifted in two years without the necessity of any showing at that time."⁵⁷⁴

SureWest, like Frontier, maintains that "the hallmark of URF should be full upward and downward pricing flexibility for all ILEC services, as this exists for all its competitors in the market. . . ."⁵⁷⁵ Nevertheless, SureWest also agrees to a price cap for basic primary residential service rates during a defined transition period of two years. The mid-sized ILEC states that it "is prepared to live with [the cap] for a two year limited transition period starting with the effective date of the decision in this phase. Furthermore, SureWest believes that the presumption should be that the caps are lifted in two years, without any necessary showing at that time."⁵⁷⁶ SureWest supports full downward pricing flexibility during this transition period.⁵⁷⁷

DRA opposes lifting price caps for basic residential service and services it deems "associated" with basic residential service. ⁵⁷⁸ These associated services include "measured local usage, ZUM, and EAS whenever those services are used in conjunction with a primary line service" and for "residential inside wire maintenance plans."⁵⁷⁹ DRA states that the Commission "should not eliminate price caps for essential telecommunications services without clear and convincing evidence that competition is sufficient to constrain the incumbents' market power over the pricing of those services."⁵⁸⁰ It then asserts that such evidence of competition is not present: "DRA, TURN, and other parties have presented substantial evidence showing that there is limited competition today for residential and single-line business basic exchange services."⁵⁸¹ DRA holds that the ILECs "failed to demonstrate that competition is ubiquitous throughout their service areas, or that competition is even significant for basic products or services."⁵⁸² It also characterizes Verizon's revenue neutrality proposal as "unnecessary."⁵⁸³

TURN similarly requests a cap on basic rates and services it deems related.⁵⁸⁴ TURN's list of related services include "ZUM, EAS, recurring and non recurring charges"; "Caller ID, call trace, 976 service, 900/976 call blocking, non-published and unlisted telephone numbers, white pages listings and busy line verification and interrupt services"; and "inside wire maintenance plans."⁵⁸⁵ TURN contends that "there is no evidence that they [cable telephony, non-cable VoIP and wireless] are currently substitutes for the essential local exchange services that are currently subject to price regulation in California today."⁵⁸⁶ TURN also urges rejection of Verizon's revenue neutrality proposal.⁵⁸⁷

DOD/FEA recommends that "each Respondent's total revenues from residential and business basic services be constrained by a revenue cap."⁵⁸⁸ Specifically, it states that a cap should be placed on the following "basic local services": (1) residential and business primary and additional lines; (2) PBX trunks to the T-1 level; (3) recurring and non-recurring charges; (4) local usage; (5) ZUM and EAS; (6) public telephone; (7) remote call forwarding; (8) telephone assistance; and (9) toll blocking.⁵⁸⁹ This proposed revenue cap would remain in place for three years, after which "the Commission can review the marketplace again and determine whether competition is sufficiently robust and ubiquitous to restrain basic local services in the mass market."⁵⁹⁰ DOD/FEA claims that currently "local service competition does not provide an effective restraint on prices in the mass market."⁵⁹¹

While it does not address basic residential service specifically, DisabRA requests that the Commission "organize a task force that would receive input from providers and the disability community, and make recommendations about services to be included for price protection."⁵⁹² DisabRA asserts that "the ILECs face little intra- or inter-modal competition in the provision of telecommunications services to Californians with disabilities, and that, as a result, the Commission cannot rely on competitive pressures from the marketplace to ensure that Californians with disabilities will have access to affordable, accessible and reliable telecommunications services."⁵⁹³

DisabRA explains that wireline service is particularly important to individuals with disabilities. It observes that "many Californians with disabilities are stuck with wireline service," because "specialized equipment that is required for them to utilize telecommunications services, including equipment provided or subsidized by the state, only works with wireline phones."⁵⁹⁴ DisabRA adds that "wireline service provides many Californians with disabilities greater security, and leaves them better prepared for emergency situations, than services such as wireless or VoIP."⁵⁹⁵

CCTA devotes a large portion of its brief to opposing Verizon's proposal for revenue neutrality. CCTA argues that "[t]he principle of revenue neutrality has no place in a uniform regulatory framework because it is a vestige of rate of return regulation that ignores revenues generated from new service."⁵⁹⁶

B. Discussion: Market Conditions Support Full Pricing Freedoms for Basic Residential Service Not Subsidized by CHCF-B, but LifeLine Makes Pricing Freedom for Basic Residential Service Inappropriate at this Time

Our analysis of how to address pricing freedoms for basic residential service must review both statutory policies and market conditions. These factors have important implications for pricing flexibility permitted in the future.

The decision of whether to permit pricing freedoms for basic residential service implicates all three statutory policies most relevant to this proceeding: (i) the policy that encourages us to rely upon competition to promote the public interest; (ii) the policy that calls for us to use technologically and competitively neutral measures to encourage a wide variety of new technologies and services; and (iii) the policy that calls for our support of special social goals. These policies are described in detail in Section III.

With respect to the first policy, we find that price controls are incompatible with the emergence of competition in the voice communications market. Price controls skew competitors' interests, and they discourage true intermodal competition for voice services, including basic residential service. This Commission, therefore, is compelled to discard price controls in the face of both state and federal policies favoring competition in the voice communications market.

Regarding the second policy, price controls placed only on market participants using one type of technology, but not on other competitors using different technologies, are clearly neither technologically nor competitively neutral. The distorted prices that result from such price controls impact consumer choices, and to the extent that consumer choices do not consider true costs, the policy harms both those offering the service and those that compete with it. This marketplace distortion may discourage a new entrant from joining or expanding its offerings in the state's voice communications market. In turn, Californians may not receive the most advanced communications technologies.

Finally, with respect to the third policy, we find that pricing policies for basic residential service are closely linked to our state's LifeLine program as well as CHCF-B, which we addressed in the prior section. The Public Utilities Code requires that LifeLine service shall "not be more than 50 percent of the rates for basic flat rate service."⁵⁹⁷ A change in ILECs' basic residential service rates has a direct impact on the amount of money available to support the LifeLine program. This statutory requirement means that any changes to basic residential rates directly impact the funding needed to support LifeLine, which is a critical universal service program designed to bring local telephone service at affordable rates to low income Californians. An in-depth examination of the relationship between the basic residential rate level and the amount of funding needed to support LifeLine is scheduled to occur in our Universal Service, Public Policy Programs rulemaking, R.06-05-028. This Commission recognizes that any changes to basic residential rates should be consistent with the LifeLine policies that will be addressed in the universal service proceeding, which was initiated on May 26, 2006. It is important that this issue be looked at in tandem with the important LifeLine policies and programs; premature action on the basic residential rates absent such a review would be unwise.

In addition to statutory policies, market conditions also guide our analysis of pricing freedoms for basic residential rates. A key question is whether competition is sufficient to ensure that telecommunications rates remain reasonable. In Section V, we addressed this question and concluded that the combination of FCC-mandated unbundling policies, the required provision of stand-alone DSL service by Verizon and AT&T, and substantial cross-platform competition obviate the need for continuing price controls on services not subsidized by CHCF-B. We, therefore, hold that market conditions support pricing freedoms for basic residential rates that are not subsidized by CHCF-B.

This policy position is consistent with that of many other states who have led the way in deregulation of the voice communications market. Verizon points out that a number of states have already made similar reforms to regulation of basic residential rates:

Alaska, Idaho, Iowa, Oklahoma, and Texas have all adopted new regulatory plans that remove any continuing price caps on basic services on dates certain from 2007 to 2010, consistent with Verizon and the other incumbents' proposals. Rhode Island removed residential price caps altogether with no automatic review of the plan, though parties can petition for a review in three years, if necessary. And Indiana just passed a law that permits yearly price increases to basic services through June 30, 2009, at which time all retail prices, including prices for basic services, will be deregulated.⁵⁹⁸

The removal of price caps on basic telecommunications services is a policy that many forward-looking states are adopting either immediately or with dates certain as they seek to revise telecommunications policies consistent with national trends.

We choose to lift price caps for unsubsidized basic residential rates on a date certain. Specifically, we order the removal of price caps on basic residential services that are not subsidized by CHCF-B as of January 1, 2009. This delay in allowing this pricing freedom to go into effect will give the Commission sufficient time to rethink the relationship between LifeLine and basic residential rates in R.06-05-028, our Universal Service Public Policy Programs proceeding. After January 1, 2009, the cap on basic residential service rates that are not subsidized by CHCF-B will no longer serve the public interest, and accordingly, the cap will sunset automatically with no further Commission action required.

Additionally we will adopt the principle of revenue neutrality in this transition phase. While we agree with CCTA that this principle has no place in a uniform regulatory framework that supports a competitive marketplace, we find that the market is not fully competitive while the Commission continues to freeze certain basic residential retail rates. Thus, the ILECs may apply the revenue neutrality principle during the transition period in order to offset Commission-mandated price changes in services still subject to price controls.⁵⁹⁹ These price changes in regulated services may be offset either with revenue neutral price increases in basic services or revenue-neutral surcharges applying to all services. We emphasize that application of the revenue neutrality measure will end on January 1, 2009, when we lift the basic residential rate price cap on services not subsidized by CHCF-B.

We find it necessary, however, to continue to place price floors on basic residential rates. While we acknowledge arguments that eliminating price floors promotes affordability, we believe a price floor remains necessary due to the statutorily imposed link between the LifeLine rate and the basic residential rate.⁶⁰⁰ This price floor on basic residential rates is necessary to ensure that we are able to support the LifeLine program in accordance with statutory objectives. Since the law caps LifeLine rates at one-half of the 1Flat Rate (1FR) basic residential rate, any decrease in the price of the basic residential rate would change both the LifeLine rate for all consumers and the corresponding subsidy drawn by every carrier in the state under that LifeLine program. Resulting fluctuations in carrier draws in the LifeLine program would require corresponding changes in end-user surcharges. Thus, we hold that we will not allow basic residential rates to fall below AT&T's current 1 Measured Rate (1MR) and 1FR rates, unless the Commission in R.06-05-028 adopts some other policy consistent with the LifeLine statutory scheme.

DisabRA has raised valid issues relating to telecommunications services and the disability community. Nevertheless we find that these issues are best left to R.06-05-028, in which we will review programs that ensure members of the disability community receive telecommunications services. In addition to examining LifeLine, R.06-05-028 also will review the deaf and disabled telecommunications program. Input will be gathered from the disability community via public hearings in the proceeding. R.06-05-028, consequently, is the appropriate proceeding for determining how to revise our policies in light of increasing levels of competition. Price changes that we make today leave in place programs of special interest to the disabled communities in California.

Furthermore, as our discussion of statutes and market conditions makes clear, neither statutes nor market conditions make it necessary to continue price regulation for any of the services "associated" with basic service. In particular, we see no reason to continue price regulation of measured local usage; ZUM; EAS; recurring and non-recurring charges; Caller ID; call trace; 976 service; 900/976 call blocking; non-published and unlisted telephone numbers; white pages listings; busy line verification and interrupt services; or inside wire maintenance plans.

Finally, we will remain vigilant in monitoring the voice communications marketplace. We will ensure that basic residential service remains affordable and does not trend above the current highest basic residential rate in the state, no matter the technology employed to offer such service. Should we see evidence of market power abuses, we retain the authority and firm resolve to reopen this proceeding to investigate such developments promptly.

⁵⁵⁵ The low price of California residential services, particularly those provided by AT&T, is well known to all regulators and has been tracked by the FCC for some time. See, e.g., Reference Book of Rates, Price Indices, and Household Expenditures for Telephone Service, prepared by Paul R. Zimmerman of the Industry Analysis and Technology Division of the FCC's Wireline Competition Bureau (Washington: FCC, 2005) (Table 1.4 show that for 94 cities throughout the United States, the cities of Anaheim, Bakersfield, Fresno, Los Angeles, Oakland, Salinas, San Diego and San Francisco are tied for the lowest rate in the national sample. Of the California cities sampled, only Long Beach and San Bernardino do not have the lowest rates in the nation.).

⁵⁵⁶ Pacific Bell, Tariff Schedule CAL. P.U.C, A-5, 6^th Revised Sheet 21; Verizon California, Tariff Schedule CAL. P. U. C. A-1, 37^th Revised Sheet 10.2.

⁵⁵⁷ SureWest Telephone, Tariff Schedule CAL. P.U.C. NO. A3. Roseville, California 3rd Revised Sheet 1.

⁵⁵⁸ Citizens Telecommunications Company, Tariff Schedule CAL. P.U.C. A-1, 5^th Revised Sheet 1.

⁵⁵⁹ Pacific Bell Opening Brief at 62. AT&T specifically proposes that this cap would apply to 1 Flat Rate ("1FR"), 1 Measured Rate ("1MR"), and where applicable, Extended Areas Service ("EAS") rates." See Opening Brief at 62 n. 229.

⁵⁶⁰ Id. (citing Harris Opening Comments at 53-54).

⁵⁶¹ Id. (citing Borsodi Opening Comments at 23-24).

⁵⁶² Under AT&T's proposal, "[s]econd and additional residential basic service lines beyond the primary line, or primary line residential basic service included in a package or bundle, would be subject to full pricing flexibility." Id. at 63 n. 229 (citing Borsodi Opening Comments at 23). Moreover, even during this transition period, AT&T argues it "should be allowed to lower primary line residential basics services below current levels. . . ." Id. at 63.

⁵⁶³ Id. at 62.

⁵⁶⁴ Id. (citing CPUC General Order 153, Section 7).

⁵⁶⁵ Id. (citing CPUC General Order 153, Section 8).

⁵⁶⁶ Id. (citing CPUC General Order 153, Section 8).

⁵⁶⁷ Verizon Opening Brief at 25.

⁵⁶⁸ Id.

⁵⁶⁹ Id. at 26.

⁵⁷⁰ Id. (citing Aron Opening Comments at ¶¶ 188-191 and Aron Reply Comments at ¶¶ 11, 114).

⁵⁷¹ Id. at 3.

⁵⁷² Citizens Opening Brief at 3.

⁵⁷³ Id. at 22.

⁵⁷⁴ Id.

⁵⁷⁵ SureWest Opening Brief at 4.

⁵⁷⁶ Id. at 25.

⁵⁷⁷ Id. at 4.

⁵⁷⁸ DRA Opening Brief at 5.

⁵⁷⁹ Id. at 6.

⁵⁸⁰ Id. at 17.

⁵⁸¹ Id. at 18.

⁵⁸² Id. at 27.

⁵⁸³ DRA Reply Brief at 19.

⁵⁸⁴ TURN Opening Brief at 34.

⁵⁸⁵ Id. at 34-35.

⁵⁸⁶ Id. at 12.

⁵⁸⁷ Id. at 49.

⁵⁸⁸ DOD/FEA Opening Brief at 10.

⁵⁸⁹ Id. at 11.

⁵⁹⁰ Id. at 11.

⁵⁹¹ Id. at 10.

⁵⁹² DisabRA Opening Brief at 22.

⁵⁹³ Id. at 12.

⁵⁹⁴ Id. at 15.

⁵⁹⁵ Id. at 18.

⁵⁹⁶ CCTA Opening Brief at 5.

⁵⁹⁷ Cal. Pub. Util. Code § 871.5(a).

⁵⁹⁸ Reply Brief of Verizon California at 11 (March 24. 2006) (hereinafter "Verizon Reply Brief") (citations omitted).

⁵⁹⁹ Indeed, application of the revenue neutrality principle may be necessary if the FCC or this Commission orders reductions in basic switched access rates. The principle is under active consideration by the FCC and is the subject of many national proposals addressing the issue of "Intercarrier Compensation."

⁶⁰⁰ Cal. Pub. Util. Code § 871.5(a).