6. Having a Positive Monthly Recurring Rate for the HFPL Results in Over-Recovery of Loop Costs

6.1 Parties' Positions

6.1.1 TURN's Position

TURN contends that the Commission must adopt appropriate measures to prevent double recovery. According to TURN, Pacific and Verizon already have an opportunity to recover their full costs through regulated rates and charges. In a letter to the FCC, Verizon's predecessor GTE stated, "[s]ince ADSL employs the existing loop for new applications, the costs of the loop are already recovered through existing rates." (Rhythms, Murray, Direct Testimony at 15.) Pacific made a similar statement to the CPUC in support of its ADSL filing. The introduction of a new charge for the HFPL allows Pacific and Verizon to collect another charge for the use of the loop, thereby providing them with double recovery.³⁵

Arguments by Pacific and Verizon that they are not collecting all of their loop costs should be rejected. These companies themselves argued to the FCC that 100% of their loop costs are recovered through existing services and charges.

TURN suggests that while the most straightforward manner to correct the over-recovery of loop costs would be to reduce basic rates by the amount of HFPL recovery, that may not be the best solution. Since HFPL is a new product it would require frequent adjustments to basic rates. TURN states that a reasonable option is to refund the HFPL income to ratepayers by an offset to the universal service fund, specifically the California High Cost Fund-B (CHCF-B). This will assure that Pacific and Verizon do not reap a windfall profit from sales of HFPL, and ensure that ratepayers as a group are reimbursed for overpayment of loop costs.

TURN rebuts Rhythms' argument that refunding the HFPL income via the universal service fund would amount to using HFPL money to support universal service, thereby creating another subsidy. Rhythms apparently misunderstands TURN's and ORA's proposal. Under their proposals, HFPL revenues are put into the high cost fund and a like amount of money is not collected from ratepayers. There is no increase in the high cost fund, nor does it represent a new subsidy. The CHCF-B is kept at the same level and is simply used as a convenient mechanism to reduce ratepayers' rates.

6.1.2 ORA's Position

According to ORA, under the current regulatory structure, Pacific and Verizon already recover the full cost of their loops. Thus, a monthly recurring charge for the use of the HFPL will result in additional revenues for them. If Pacific and Verizon were allowed to keep these revenues without any offsets, there would be a windfall profit from sales of the HFPL UNE. In order to prevent the over-recovery of loop costs, Pacific and Verizon should be required to refund the revenues derived from the sale of the HFPL to ratepayers by an offset to their draws from the CHCF-B. Specifically, these new revenues should be offset dollar-for-dollar against Pacific's and Verizon's external subsidy draws.

6.1.3 Rhythms' Position

Rhythms concurs with TURN and ORA's assertion that since the ILECs already fully recover their loop costs, a monthly recurring charge for use of the HFPL would result in new revenues for them that amount to double recovery.

6.1.4 Pacific's Position

According to Pacific, Pacific does not receive a "windfall" from a positive price for access to the HFPL because that argument relies on the premise that Pacific fully recovers the costs of the loop from basic service revenues. Pacific asserts that its basic exchange service, including the local loop, is priced well below cost. As described by Pacific's witness Scholl, the sum of Pacific's 1FR [residential flat-rated service] revenues, the associated End User Common Line (EUCL) revenues and the CHCF-B revenues equal less than the cost of providing the local loop. Pricing the shared loop at $5.85 does not comprise a "windfall", but instead merely helps to make up this shortfall. After all, as Scholl states, any CLEC can purchase an unbundled loop for the purpose of providing DSL service and can then provide an end-user with both basic and DSL service over that loop. If there was such a windfall as TURN's witness Murray describes, there would be a stampede of others seeking to provide that combination themselves. The fact that such stampede has not occurred clearly refutes her claim.

Pacific rebuts Rhythms claims that "the Commission has already created an explicit universal service funding mechanism that is designed to deliver all of the subsidy that the Commission deems necessary to support residential basic exchange service." (Rhythms Opening Brief at 21.) According to Pacific, Rhythms is wrong. The Universal Service proceeding provided subsidies to high cost areas-areas in which lines cost more than a Commission-determined average-not to all residential 1FR lines. The Universal Service decision did not foreclose the Commission from following NRF and allowing new products to contribute to loop costs.

Second, under NRF principles, a positive price for access to the HFPL is not a windfall but instead an appropriate incentive for an ILEC to develop innovative products and services. As Pacific's witness Jacobsen described in his testimony, an important principle of NRF is that reward should follow risk. Clearly, Pacific's shareholders bear the risk of the investment Pacific has made to develop widespread DSL availability. Under NRF, shareholders should now be compensated for this risk. Pacific states that the price of $5.85 is far from a windfall, but instead merely some compensation for shareholders in exchange for the risks they have borne.

Pacific asserts that a $5.85 price is consistent with the Commission's holdings in its NRF proceeding. Two of the goals of NRF are the encouragement of technological advancement and full utilization of the network through retaining and expanding the customer base for existing services and adding new services. HFPL is a prime example of a new service that has been developed through technological advancement. In order to ensure that NRF's goals are met, Pacific must be allowed to charge reasonable prices for new products that are developed through these technological advancements. Consequently, a $5.85 price for access to the HFPL is consistent with NRF.

Pacific states that although the evidence indicates that no offset is appropriate, it is also clear that the CHCF funding mechanism should not be modified in this proceeding. The funding mechanism and purpose was defined in D.96-10-066. Parties who recommend that the Commission now divert HFPL revenue into that fund are essentially asking the Commission to modify that Decision. This is not the proceeding in which to modify D.96-10-066. This proceeding has involved only a select few active parties. Other interested parties should be entitled to appear and comment on changes to the CHCF-B.

6.1.5 Verizon's Position

Verizon asserts that it is not appropriate to offset any portion of a positive price for the HFPL. First, revenue derived from the HFPL element should not be considered a windfall profit requiring any sort of offset. Under Verizon's proposed methodology, a non-zero price would be equal to the direct additional cost associated with the HFPL, plus a reasonable allocation to common costs. According to Verizon, this is no different from any other UNE price established by the Commission.

Second, Verizon states that even if the Commission determines that a non-zero price for the HFPL represents an allocation of loop costs or a reasonable contribution for common cost recovery, the revenues derived in this manner would not constitute a windfall profit requiring a rate adjustment or offset. Verizon operates under the Commission's NRF, and is regulated on an incentive basis. As such, Verizon's shareholders are at risk for their management's ability to generate greater efficiencies, cost savings, and revenue sources to offset the effects of inflation and losses of revenue to other carriers in the competitive marketplace. On the other hand, Verizon's ratepayers are insulated from negative impacts due to inflation or competitive losses. In this context, the HFPL is nothing more than a new revenue source. According to Verizon, there is absolutely nothing unique or special about the HFPL revenues.

Verizon asserts that its draw from the CHCF-B should not be either reduced or offset if there is a positive price for the HFPL. Verizon is already fully offsetting its draw from this fund via compensating surcredits. Given that, any additional rate reductions or offsets would be inappropriate.

6.1.6 Discussion

Both Pacific and Verizon asserted in their filings at the FCC when they filed for authority to offer ADSL service that they were recovering the full cost of the loop from existing services. In its June 26, 1998 reply filing at the FCC, Pacific asserts as follows:

Several petitioners contend that Pacific must assign outside plant (local loop) costs to its ADSL service. But Commission rules impose no such requirement. FCC Rule 61.38 requires LECs to identify the direct cost to provide the proposed new service. Pacific proposes to transmit ADSL over loops already in service. Pacific already recovers the costs of those local loops under tariffs already approved by the Commission and state regulators. Loop costs therefore contribute nothing to the direct cost of ADSL service.³⁶

Pacific made a similar statement in responding to protests to its filing at this Commission of an intrastate ADSL tariff:

Protestants fail to come to grips with the fact that Pacific Bell's retail end users already pay the Commission-approved and FCC approved prices that recover the cost of the copper loop over which the ADSL service is placed.³⁷

Verizon has made similar attestations. Verizon's predecessor GTE has stated:

[s]ince ADSL employs the existing loop for new applications, the costs of the loop are already recovered through existing rates.... ³⁸

The ILECs have stated to both this Commission and the FCC that they recover the cost of the loop through tariffed services. They made that statement at a time when it was to their benefit not to allocate any costs to the high frequency portion of the loop, and there were no competitors using those line-shared loops. We do not find convincing their more recent assertions that they do not recover the costs of the loop from their tariffed services. Their arguments are self-serving attempts to retain the revenues they obtain from leasing the HFPL to other carriers.

We agree with TURN's conclusion that the introduction of a charge for the HFPL allows Pacific and Verizon to collect another charge for the use of the loop, thereby providing them with "double recovery." In other words, if Pacific and Verizon were to assess a charge for the data portion of the loop, they would recover more than the full cost of the loop. We have already rejected Pacific's allegation that it should keep the HFPL revenues to make up for the shortfall in residential basic exchange service and found that it violated the FCC's rules for pricing of UNEs. We also rejected Verizon's "embedded constraint" theory, which would have allowed the company to recover costs associated with plant in its copper network as being inconsistent with the FCC's rules for pricing of UNEs.

Pacific and Verizon muddy the waters with their allegations that NRF principles mandate that shareholders who bear the risk of investment in DSL technology should be compensated for this risk. Verizon sees DSL service as nothing more than a new revenue source, with nothing special about HFPL revenues. We disagree. We stand by the principles we adopted over a decade ago when we implemented incentive regulation for our two largest ILECs. However, while our NRF framework is still in place, the world of telecommunications changed dramatically with passage of TA96. The FCC has enacted rules to deal with the new regulatory environment, and included in those rules are rules for the pricing of UNEs. We are obliged to follow the FCC's rules in the pricing of UNEs.

We find that Pacific and Verizon should not be allowed to retain the HFPL revenues since it would result in their over-recovery of loop costs. In addition, it eliminates any possibility of cross-subsidization, since all CLECs-including ASI and VADI-would pay the same rate and those revenues would not be retained by the ILECs.

Parties propose that the HFPL revenues should be returned to ratepayers, and we concur with that suggestion. However, we need to examine the best way to return the revenues to ratepayers and determine which ratepayers should receive the benefit.

TURN suggests that the most straightforward manner to correct the over-recovery of loop costs would be to reduce basic rates by the amount of HFPL recovery, but then rejects that option because it could result in frequent adjustments to basic rates.

ORA and TURN both present slightly different options for returning HFPL revenues to ratepayers. Both options involve use of the CHCF-B. ORA proposes to require the ILECs to refund the revenues from the sale of the HFPL by an offset to their draws from the CHCF-B, while TURN proposes that the revenues from HFPL be transmitted to the CHCF-B and used to offset the amount of surcharge collected from ratepayers. We agree with Pacific's statement that this proceeding is not the appropriate place to modify our universal service funding mechanism, as adopted in D.96-10-066.

In their comments on the DD, Pacific, Verizon and the Joint CLECs³⁹ assert that the proposal to refund the HFPL revenues to all basic exchange ratepayers would constitute an illegal subsidy for voice services. The Joint CLECs assert that by diverting the refund away from the actual customers who pay the HFPL charge, the DD's refund mechanism would cause DSL customers to pay more for the local loop than voice-only customers. Thus, the DD's proposal sets up an improper cross subsidy-taking revenues from DSL customers and giving those revenues to the majority of local exchange customers.

TURN and ORA defend the DD's surcredit method, stating that the surcredit mechanism is designed to ensure the ILECs do not over-recover the costs of the loop. As TURN's witness Roycroft discusses, it is appropriate to credit this money back to all local exchange customers, as opposed to just DSL customers, because all users of the loop benefit from the increased economies of scope brought on by line sharing. These increased economies of scope result in lower costs for all services using the loop. While in a competitive market this decrease in costs would be reflected in lower prices, because this is not a truly competitive market regulators must supervise the allocation of these savings. A surcredit, while not as direct as a decrease in local exchange rates, is an appropriate method of allocation. (Roycroft for TURN, Reply Testimony at 10-11, 13.)

We concur with the joint commenters that refunding the HFPL revenues to all basic exchange ratepayers would constitute an illegal subsidy for voice services. The refund should go to those customers that actually subscribe to DSL service.

While parties proposed returning the revenues to DSL customers, they did not flesh out their proposal so we must do so. First, parties propose to return the revenues to the actual customers who pay the DSL charge, but the actual customer who pays the HFPL charge is the CLEC, not the DSL end-user customer. Also, the DSL customers are customers of the CLEC, not the ILEC. This entails having the ILECs return the revenues to CLECs, who would beordered to return the revenues to their ratepayers. However, since only the ILECs are respondents in this proceeding, and the CLECs are not, we will take the steps necessary to make the CLECs respondents to this proceeding.

We conclude that all certificated CLECs should be named as respondents to the Permanent Line Sharing phase of the OANAD proceeding. In order to give those CLECs notice and an opportunity to be heard, this DD will be served on the entire list of certificated CLECs. CLECs and other parties will be given 15 days to comment on the proposal to make the CLECs respondents to the proceeding and to comment on other elements of the DD. Parties to this proceeding may file comments, but should not use this as an opportunity to repeat previous comments.

On a going forward basis, the ILECs shall return the HFPL revenues to each CLEC that purchased HFPL during the previous quarter. ILECs shall make those payments within 30 days of the close of each calendar quarter. CLECs have 90 days after receiving the money from the ILEC to disburse it to their DSL customers. At the same time that the money is sent to the CLECs, each ILEC shall send a quarterly report to TD reporting on the disbursement of the money. Each ILEC's report shall include a list of the CLECs that received a refund and the amount of money returned to each.

Each CLEC shall file a report with TD each quarter that shows: 1) the amount of money received from each ILEC and the date the funds were disbursed to their DSL customers. If a CLEC is unable to locate a DSL customer to make the refund, that money is not to be retained by the CLEC, but escheats to the state's general fund, in accordance with the California Unclaimed Property Law (Calif. Code of Civil Procedure 1500 et. seq.). Each CLEC's report should include information on the amount sent to the state's general fund. The CLECs' reports are due 30 days after the end of each calendar quarter. TD shall monitor the reports from ILECs and CLECs and notify the assigned ALJ and the Commission of any irregularities.

Parties raised an additional concern with the DD's refund mechanism. The Joint CLECs assert that once Pacific and Verizon reintegrate their data affiliates, the ILEC may not incur a positive monthly charge for the HFPL, which would result in a price squeeze. TURN responds that the problem can be easily remedied by requiring an ILEC to impute the monthly recurring charge to its DSL service. According to TURN, this would eliminate the price squeeze problem and ensure non-discriminatory pricing treatment of DSL providers. Verizon argues that the Joint CLECs' analysis is incorrect. CLECs have the option of leasing the entire UNE loop to provide both voice and data services, thereby avoiding the HFPL rate entirely. According to Verizon, even if a CLEC does not provide voice services, it can jointly market an integrated package with another CLEC that would use the low frequency portion of the loop. According to Verizon, CLECs have options available to prevent any price squeeze.

We are concerned with the potential of discriminatory treatment if/when the ILECs reintegrate their data affiliates. Verizon has already filed to reintegrate VADI in A.01-11-014, and that issue will shortly be pending before the Commission. We do not have the record in this proceeding to address this potential problem, but we will require the assigned ALJ to open the record to collect additional comments on the potential of a price squeeze if an ILEC reintegrates its data affiliate.