IV. Reasonableness of Settlement Terms

A. Recovery Amount

We conclude that Settlement recovery amount of $87.5 million fairly balances the opposing interests of Pacific, seeking to recover the full $175 million in costs, versus consumer and competitor interests, seeking either no cost recovery or at least less recovery than Pacific requested.

Pacific claimed $175 million of local competition implementation costs for recovery in its December 20, 1999 filing. The settlement equates to a 50% disallowance of the principal amounts that Pacific presented in its December 20, 1999 filing. Pacific had also sought to recover interest on the amounts that it was accruing in its memorandum account. Thus, when the time value of money is considered, the settlement amount of $87.5 million equates to less than 50% recovery by Pacific of the total amount originally sought. In addition, Pacific gives up its claim to recover any additional implementation costs incurred for 1999 or beyond that it otherwise could seek based on Commission or FCC orders issued prior to April 18, 2000. That waiver is limited by paragraphs 10 and 11, which exclude costs for which recovery mechanisms already exists.

Although the opposing parties reached settlement before submitting testimony proposing alternative recommendations in response to Pacific's December 20 filing, the opposing parties did engage in extensive discovery, probing the details of Pacific's showing. Approximately 530 data request questions were propounded. Pacific provided over 8,500 pages of documents in response. Six days of depositions of 14 Pacific representative were undertaken. The parties engaged in settlement discussions after all of this discovery was completed. Settlement was reached after the parties had been able to fully assess the strengths and weaknesses of their respective cases.

While the settlement amount does not equate to a disallowance as large as opposing parties would seek in litigation, it represents a reasonable compromise given the risk that the Commissions could approve a much smaller disallowance than parties would urge. We therefore believe that the proposed recovery amount of $87.5 million represents a reasonable compromise of the differing affected interests of the sponsoring parties. We make this judgment based upon the framework for evaluating settlements discussed previously, weighing the trade-off relating to the risk, expense, complexity, and likely duration of further litigation of Pacific's implementation cost recovery versus the amount of the settlement compared to Pacific's original proposal.

B. Recovery Method

The Settlement Agreement provides that the amount of $87.5 million will be recovered over two-years, beginning January 1, 2001 ($43.75 million in 2001 and $43.75 million in 2002). For each of the two years, the recovery will be by a surcharge calculated using the billing base approved in Pacific's Annual price cap filing for that year. The surcharge percentage, as calculated, shall be applied to Pacific's bills for toll, exchange, and access services, as described in Rule 33 of Pacific's tariffs. The recovery amount would result in 0.737% surcharge if calculated based on the most recent billing base approved.

We conclude that the two-year recovery period is more advantageous than the three-year period originally proposed by Pacific. Moreover, Pacific's existing surcredits that carry over into the years 2001 and 2002 total an amount greater than the prospective .737% surcharge for implementation cost recovery. Approval of the Settlement Agreement, therefore, will not result in a net surcharge on customer bills. Shortening the recovery time would likely cause the surcharge to exceed the scheduled surcredits for 2001. Lengthening the time for recovery could have raised potential issues of carrying charges that may have resulted in a higher settlement amount. Thus, the two-year recovery period strikes a reasonable balance.

Spreading the recovery over all three groups of services in Pacific's Rule No. 33 Billing Surcharge (i.e., local, toll, and access) is also reasonable. The larger the billing base, the smaller the per-customer surcharge, with less effect on individual customers. Although certain parties do not agree that costs of implementing local competition should be borne by long distance carriers, especially as it negatively impacts the legal requirement for cost-based access, other aspects of the settlement led to a compromise on this position. These aspects include the substantial reduction in the recovery amount and the efficiency of the collection methodology. In D.98-11-066, the Commission sought to extend implementation cost recovery to CLCs and their customers through the use of a per-line surcharge as the recovery mechanism. Following applications for rehearing of D.98-11-066 however, the Commission reconsidered its plan to use a per line surcharge as the recovery mechanism. The Commission agreed that a clearer definition was needed of the lines to which the surcharge should apply. The Commission also agreed that a per-line surcharge remitted by the CLCs to Pacific and GTEC would reveal proprietary CLC information - - the number of lines CLCs are serving - - to their ILEC competitors. If the transmission of the CLC's surcharge funds were to be managed by Pacific, then carriers would have to report their revenues to Pacific so that Pacific could verify that they were receiving the correct amounts. Carriers consider their revenues, like their number of access lines, to be proprietary. The use of the Rule 33 surcharge/surcredit in Pacific's tariffs as a recovery mechanism, however, avoids the problems of disclosing proprietary information or of requiring that the Commission manage the transmission of funds.

TURN and ORA believe that the ideal would be to have the most diverse billing base possible, including that of CLCs, to extend recovery beyond just the ILEC customers. That goal is accomplished in part by the inclusion of resold services in the Rule 33 mechanism (currently those services are in the access basket but this year they will move to the appropriate exchange and toll baskets), although resale billings to CLCs are small. Further, by applying the surcharge to access, the funding base is more diversified and reaches corporations that have relatively large CLC operations. In light of the problems with using a surcharge on all retail revenues or any other method that proportionately would reach CLCs and their customers, using a Rule 33 surcharge applied to exchange, toll and access as provided in the Settlement is a reasonable cost recovery mechanism.