III. Applicable Standards
A. The Consensus Costing Principles
During the first years of the Commission's efforts to cost "basic network functions," the precursors to UNEs, the Commission adopted a set of "Consensus Costing Principles" (CCPs) that had been negotiated and agreed to by AT&T, MCI, Pacific Bell, GTEC and others for use in those early cost proceedings.13 (See D.95-12-016, Appendix C.) The CCPs in large part foreshadowed the FCC's TELRIC principles and are largely based on the concept of determining incremental costs that reflect the entire quantity of output provided. Additional critical concepts incorporated in the CCPs include:
· Principle No. 1: Long run implies a period long enough that all costs are variable.
· Principle No. 2: Cost causation is a key concept in incremental costing.
· Principle No. 3: The increment being studied shall be the entire quantity of the service provided, not some small increase in demand.
· Principle No. 6: Technology used in a long run incremental cost study should be the least-cost, most efficient technology that is currently available for purchase. This principle assumes that a TSLRIC analysis should be based on the existing or planned location of switching and outside plant facilities using the least-cost, most efficient technology.
· Principle No. 7: Costs shall be forward looking.
B. The TELRIC Standard
The Telecommunications Act of 1996 (the Act) requires incumbent local exchange carriers (ILECs) such as Verizon to interconnect with any requesting telecommunications carrier at rates, terms and conditions that are just, reasonable, and nondiscriminatory, and in accordance with Section 252 of the Act. (Section 251(c)(2).) Section 252(d) of the Act sets the pricing standard for interconnection and network element charges and states that when state commissions determine a just and reasonable rate for purposes of Section 251(c)(2), the rate shall be "based on the cost (determined without reference to a rate of return or other rate-based proceeding) of providing the interconnection or network element," it shall be nondiscriminatory, and it may include a reasonable profit.
Following the passage of the Act, the FCC set forth the applicable costing standard to implement the Act in its August 1996 First Report and Order. Federal regulations provide that state commissions shall comply with the FCC's forward-looking economic cost-based pricing methodology when setting UNE rates for incumbent LECs such as Verizon. (47 C.F.R. Sec. 51.503(b)(1).) Generally, the FCC's forward-looking economic cost of a UNE equals the sum of (1) the TELRIC of the element, and (2) a reasonable allocation of forward-looking common costs. (47 C.F.R. Sec. 51.505(a).) The TELRIC of an element is "the forward-looking cost over the long run of the total quantity of the facilities and functions that are directly attributable to, or reasonably identifiable as incremental to, such element, calculated taking as a given the incumbent LEC's provision of other elements." (47 C.F.R. Sec. 51.505(b).) In providing further guidance on the concept of "forward-looking economic cost," the FCC specifies that the TELRIC of an element "should be measured based on the use of the most efficient telecommunications technology currently available and the lowest cost network configuration, given the existing location of the incumbent LEC's wire centers." (47 C.F.R. Sec. 51.505(b)(1).)
Finally, the FCC regulations specify that "embedded costs" and "retail costs" shall not be considered when calculating the forward-looking economic cost of a UNE. (47 C.F.R. Sec. 51.505(d).) "Embedded costs" are defined as "costs that the incumbent LEC incurred in the past that are recorded in the incumbent LEC's books of accounts." (47 C.F.R. 51.505(d)(1).) "Retail costs include the costs of marketing, billing, collection, and other costs associated with offering retail telecommunications services to subscribers who are not telecommunications carriers..." (47 C.F.R. 51.505(d)(2).)
C. Supreme Court Review of TELRIC Standard
The FCC's TELRIC methodology has been upheld by the U.S. Supreme Court following challenges to the methodology from ILECs. (Verizon Communications Inc. v. FCC, 122 S.Ct. 1646 (2002).) ILECs argued that the TELRIC methodology resulted in costs that are too low because it is based on a "hypothetical" and "most efficient" network rather than the incumbent's actual network. The Supreme Court rejected this argument and stated that:
As for an embedded-cost methodology, the problem with a method that relies in any part on historical cost, the cost the incumbents say they actually incur in leasing network elements, is that it will pass on to lessees the difference between most-efficient cost and embedded cost. Any such cost difference is inefficiency, whether caused by poor management resulting in higher operating costs or poor investment strategies that have inflated capital and depreciation. If leased elements were priced according to embedded costs, the incumbents could pass these inefficiencies to competitors in need of their wholesale elements, and to that extent defeat the competitive purpose of forcing efficient choices on all carriers whether incumbents or entrants. The upshot would be higher retail prices consumers would have to pay. (Verizon, 122 S.Ct. at 1673.) (Citations and footnotes omitted.)
D. Updates to TELRIC
The FCC's Triennial Review Order (TRO)14 and Triennial Review Remand Order (TRRO)15 provide additional clarification on key inputs to TELRIC modeling and price floors calculations. We address the specific clarifications from the TRO and TRRO in the sections below where they apply.
E. Commission Cost Modeling Criteria
In a July 2002 ruling, the ALJ directed that all cost filings in this proceeding should adhere to the same criteria as those applied in the Commission's reexamination of UNE prices for SBC.16 Specifically, any cost models or studies must allow parties to:
1. Reasonably understand how costs are derived by:
a. Providing access to all interested parties to the model and all underlying data, formulae, computations, software, engineering assumptions, and outputs; and
b. Allowing interested parties to examine and modify the critical assumptions and engineering principles.
2. Generally replicate the cost model or cost study calculations; and
3. Propose changes in inputs and assumptions in order to modify the costs produced.17
In Section V.C below, we shall discuss whether the Verizon and HM 5.3 models adhered to these criteria.
F. Burden of Proof
As part of its implementation of the Act, the FCC adopted regulations that provide the ILEC bears the burden of proving the UNE rates it proposes do not exceed forward-looking economic cost. (47 C.F.R. 51.505(e).) In adopting these regulations, the FCC recognized there was asymmetric access to cost data because ILECs have greater access to cost information necessary to calculate incremental costs of providing UNEs. Therefore, in this proceeding, Verizon has the burden to demonstrate that the rates it proposes do not exceed
forward-looking economic cost for each UNE.
The other parties that have presented proposals for TELRIC costs or inputs to cost models, bear the burden of persuading the Commission that their proposals are reasonable given the FCC's TELRIC standards and the Commission's CCPs.
13 The CCPs were developed to support the Total Service Long Run Incremental Cost (TSLRIC) methodology, which derives costs based on services offered rather than network elements. The principles are also considered applicable to TELRIC analyses.
14 In the Matter of Review of the Section 251 Unbundling Obligations of Incumbent Local Exchange Carriers (CC Docket No. 01-338); Report and Order and Order on Remand and Further Notice of Proposed Rulemaking, FCC No. 03-36, (rel. Aug. 21, 2003) ("TRO").
15 In the Matter of Review of Unbundled Access to Network Elements, Review of the Section 251 Unbundling Obligations of Incumbent Local Exchange Carriers (WC Docket No. 04-313, CC Docket No. 01-338); Order on Remand, FCC No. 04-290, (rel. Feb. 4, 2005) ("TRRO").
16 See Application (A.) 01-02-024 and consolidated proceedings (hereinafter the "SBC UNE Reexamination").
17 Administrative Law Judge's Ruling Revising Schedule for Setting Unbundled Network Element Rates for Verizon California, 7/23/02, p. 4.
