BEFORE THE WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION In the Matter of the Petition for an Investigation Into the Cost of Universal Service and to Reform Intrastate Access Charges. DOCKET NO. UT-970325 REPLY COMMENTS OF PUBLIC COUNSEL Over the past several months the staff has formulated a series of alternative approaches to access charge reform. While the first proposals presented very broad principles and a comprehensive approach, the draft rule circulated at the SBEIS Committee meeting.on March 27 appears to focus on a subset of the alternatives that are a first step on the road to access charge reform. In general, Staff’s first steps appear to be reasonable, but there are crucial unanswered questions in the draft rule and the broader set of proposals. Public Counsel believes that it is important to establish the principles and steps that will be followed in advancing access charge reform to its conclusion. Public Counsel notes that the draft rule has not yet been published in a Notice of Proposed Rulemaking (CR 102) and reserves the right to supplement these preliminary comments. These comments draw upon the earlier rounds of comments in this proceeding, as well as the presentation of Public Counsel’s expert at the Commission’s open meeting on March 17, 1998. A copy of his remarks, annotated with references to the most recent round of comments by other participants, is attached as Appendix A. PRINCIPLES FOR UNIVERSAL SERVICE AND ACCESS CHARGE REFORM At the outset, Public Counsel recommends that the Commission apply the following principles in implementing access charge reform. These are the principles by which Public Counsel has evaluated the staff proposal and draft rule. The goal should be to have prices set at forward-looking economic costs and recovered in an efficient manner. Universal service funds should only support costs at those efficient levels. The telecommunications network should be treated as an integrated, multi-product enterprise delivering a wide range of services. All services should be required to pay for all facilities that they utilize. Recovery of a share of joint and common costs is not a subsidy. The loop is a shared cost. To the extent that they are effective, market forces should be relied upon to drive prices to costs and to drive costs to efficient levels. Where they are not effective, prescriptive regulation must be implemented to accomplish reform. Major changes in access charge reform should be introduced in phases and each step in the process should move toward the ultimate goal. STAFF ALTERNATIVES AND PROPOSALS The draft rule proposes: (1) to set terminating access equal to local termination charges or the actual cost (determined on a TSLRIC basis), and (2) allow companies who are authorized to collect universal service support to do so through a universal service charge collected as a termination rate element. The alternatives that have been identified by the Staff, but not included in the draft rule include: Any reduction in revenue result from lower terminating access and providing a universal service rate element can be offset by increasing originating access, or other rates as the Commission may approve. Reduce access charges to offset universal service funding, and shift part or all of remaining access charges to local rates. Levy access charges on consumers instead of companies. Reduce access charges to offset universal service funding, and order an additional decrease in access charges with no offsetting local rate increase. The Draft Proposal for the First Step of Access Charge Reform The draft rule is a reasonable first step in access charge reform for the following reasons. To the extent that a universal service fund is created and subsidies have been implicit in access charges, the logical starting point is that they should be removed from access. This approach rejects the claim that margins on vertical services should be reduced at the same time as access charges. Access is an input for the production of a related service (long distance) and therefore should be reduced first. As the staff analysis, and several commenters point out, termination is subject to much less competition than origination. Therefore, to the extent that regulatory action is necessary, it should start with termination. The staff has clarified the use of the word “cost” in the draft rule to make it clear that the cost of a service should include contribution to common costs. Although the draft rule is a good first step, it leaves a great deal of uncertainty. Collecting the Universal Service Fund The greatest uncertainty resides in the universal service funding mechanism. The universal service funding paragraph raises some questions. It is certainly consistent with the Staff rationale for lowering termination charges first and to then seek to fund universal service by imposing a charge on termination. If termination is not competitive, then the universal service rate element will be non-by passable. Everyone who terminates will pay. The difficulty arises from the need to fund universal service by charges on all telecommunications service providers in a competitively neutral. It is arguable, and certainly would be argued by long distance companies, that the universal service rate elements must be collected on all terminations, local and long distance. If local calls do not pay the rate element, then local service providers are not contributing to the universal service fund. This would likely trigger a challenge under the Telecommunications Act. In most states universal service funds have met this requirement by imposing gross receipts fees, or total retail receipts fees (gross receipts net of wholesale sales). The decision to use terminating access is novel and could work, but the details must be worked out. MOVING TERMINATING AND ORIGINATING CHARGES TO COSTS The draft rule does not address the question of what happens if universal service funding is not adequate to lower terminating access charges to cost. This was, of course, the subject of at least three of the other alternatives identified in earlier proposal. Nor does it address the possibility that originating access may be above cost and in need of reform. Treatment of Originating Access Charges Staff’s proposal includes the option of raising originating access charges. This approach, while offering some benefits, is not without problems. If access is already well above cost, however, it sends the price trend in the wrong direction. In addition, the proposal is premised on the existence of competition. To the extent competition does not materialize, the proposal will have limited effectiveness, since originating access will not be subject ot downward pressure. Staff Should Consider the Use of a Flat Rate Element to Recover At Least a Portion of Access. Public Counsel believes that a fixed charge per line to recover a reasonable share of loop costs should be considered as a means to lower terminating access to cost. This issue is discussed in Appendix A. Set Access at Forward Looking Economic Costs What happens if a universal service fund is created and a fixed per-line charge is implemented and access charges are still above costs? If the Commission believes that it must continue to lower access charges, Public Counsel believes that the Commission should conduct a proceeding to examine rigorously the forward looking economic costs of providing service. Public Counsel believes that it is only such forward-looking economic costs that are the subject of the subsidy proceeding. Access would be set at economic costs, but other rates would not be changed. Increases in Local Rates Should be the Last Measure Taken Before the Commission considers raising basic service rates it should take the following steps. The Commission should first estimate costs at efficient levels. It should assign responsibility for common costs that are shared by all services to those services. It should establish a universal service fund (estimated on the basis of all intrastate revenues). Only then, if there is still a need to lower access charges, should the Commission consider raising local rates. If local rates are to be raised, it should be over time. The implementation of any necessary rate rebalancing would be undertaken only after each of the prior steps is taken and the effects are observed. Public Counsel believes that the possibility that any such rate rebalancing would be necessary is extremely small. IMPLEMENTATION ISSUES If the creation of a universal service fund and the implementation of a fixed per-line charge are adequate to lower terminating access to cost, it would be reasonable for the Commission to pause in access charge reform. Such a pause would enable the Commission to assess the effectiveness of its pass-through mechanism and the development of market forces. Creating Market Forces to Drive Prices to Efficient Levels The Staff’s proposal to shift costs to originating access places significant reliance on competitive market forces to lower originating access. For this approach to be successful, however, local competition must be implemented. To date, there has been little development of competition in Washington. Should the Commission decide to adopt the Staff proposal, it should do so for a specific time period, in order to determine whether competitive forces are having the desired effect. The Commission’s own efforts to implement local competition will be critical during this period, as well as those of incumbent companies. DATED this 8th day of April, 1998. CHRISTINE O. GREGOIRE Attorney General Simon J. ffitch Assistant Attorney General Public Counsel PAGE 1 APPENDIX A ACCESS CHARGE REFORM AND UNIVERSAL SERVICE: A PRIMER ON ECONOMICS, LAW AND PUBLIC POLICY STATEMENT OF DR. MARK N. COOPER OPEN MEETING WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION MARCH 17, 1998 The local exchange companies (LEC) insist that the Telecommunications Act of 1996 requires the Commission to ensure that each and every line in the state is profitable. The most explicit statement of this position can be found in the Comments of GTE Northwest Incorporated, February 13, 1998 (hereafter, GTE), pp. 5, 9. Not only must every line cover its costs, which the companies define as every penny of historic embedded costs, but they also insist that it must do so on the basis of the revenue garnered from basic monthly service only. GTE, p. 17.This view of the Act would compel the Commission to either create a huge universal service fund or to radically raise basic service charges. Figure 1 depicts this view of current access charges (see attached). Having come a long way I will be simple and clear in delivering my response. The LEC view of the 1996 Act is wrong. It is wrong on the economics, wrong on the law, wrong on the constitution, and bad public policy. The consumer view is that the current gap between access charges and the cost of access is that it is caused by a variety of factors (see Figure 2). Each of these factors should be dealt with by a different policy (see Figure 3). In my remarks today, I outline the economic, legal and public policy reasons that the Commission should implement this alternative view of access charge reform and universal service policy (see Figure 4) ECONOMICS Let me start with the cornerstone of the analysis -- the economics. No one builds facilities to enter markets that are inherently multi-product in nature and enjoy substantial economies of scale and scope on the basis of the profitability of only one-quarter of the products that can be produced. They cannot succeed with such an entry strategy because others who price their output in recognition of the multiple products they are selling would pick them apart. They could only concoct such a strategy if they can get some policy maker or regulator to insulate them from rational economic competition. That is the purpose of the huge, overblown universal service funds that the LECs have proposed across the country. The economic evidence that the telecommunications network is a multi product enterprise enjoying economies of scale and scope is overwhelming. o On the supply-side all long distance calls use the network exactly the same way local calls do. Comments of Western Wireless Corporation, February 12, 1998 (hereafter, Western), p. 5, (supporting this view). Vertical services (like Call Waiting, Call Forwarding and Caller ID) are supported by all parts of the network. o On the demand-side, customers expect to receive long distance service when they order telephone service. Vertical services are strong complements of basic service. If you sell basic to a customer, competitors are very unlikely to sell that customer Call Waiting. o Companies are desperate to sell local service and long distance bundled together. In such a bundle, why is local service the cost causer, as the LECs claim? For decades the companies have argued that local service causes the loop by the metaphysical assumption that local is what people really wanted. In this proceeding, both GTE (pp. 8, 10) and US West Communications Inc.(USWC) February 13, 1998 Comments, p. 16, state their objection to treating the loop as a common cost. Both support a subscriber line charge as a mechanism for circumventing the decision to treat the loop as a common cost. Now that the companies are falling all over themselves to sell bundles of services, that fiction should be put to rest once and for all. In truth, since the first decade of this century, the network, including the loop has been consciously designed to serve local and long distance. Long distance was not an afterthought; it was always a forethought, included in the design, development and deployment of the network, as are vertical services today. THE LAW The law [Telecommunication Act of 1996] recognizes the fundamentally multi-product nature of the telecommunications network. It repeatedly recognizes that advanced services and basic service are linked. It recognizes that competitive and non-competitive services will be commingled on the network. Its purpose is to advance this multi product network. The law directly addresses the revenue responsibility of these various services. Comments of Tracer, February 13, 1998 (hereafter, Tracer), p. 10, (accepting the notion that contribution toward loop costs should be made by other services). Competitive services are not to be cross subsidized and they are required to make a contribution to joint and common costs. Basic service is to pay no more than a reasonable share of joint and common costs. The Conference report went out of its way to state that basic service could even pay less than a reasonable share of joint and common costs. Nowhere does the statute say anything about rate rebalancing. I guarantee you; not one member of congress stood up on the floor and said that basic service rates would double, as the industry has tried to legislate in Florida, in order to promote competition. The companies have tried to bootstrap the requirement in the Act that support for universal service be specific, predictable, sufficient and explicit into a broad requirement for rate rebalancing, but this effort misinterprets the Act. GTE, pp. 7, 17. o The recovery of joint and common costs across all services that share the underlying facilities certainly does not violate this prescription. o Claims that revenues from vertical service are not predictable are contradicted by decades of rate making. Most of the vertical service revenues come from services that are at least strong complements of basic service. They have been included in ratemaking even though they have a much higher elasticity of demand than basic service. The certainty that companies seek in their revenue stream is far beyond current regulatory practice and beyond anything contemplated by the Act. o The fact that companies might lose market share, and therefore have inadequate revenues, certain does not contradict the Act, which sought to increase competition in an industry that had been a monopoly There is yet another reason that the Act does not provide a basis for extensive rate rebalancing. It can be readily interpreted to mean that the mandate placed on the states to provide specific, predictable and sufficient support for universal service applies only to instances in which the state mandates additional definitions and standards of universal service beyond the federal definition. The state can declare current rates just, reasonable and affordable and under the statute they need do no more. TRACER (p. 6) points out that, for both US West and GTE, revenues presently cover costs for services which are sold on a geographically averaged basis that is equal in scope to the geographic areas in which unbundled network elements are made available. There is an intuitive appeal to the argument that universal service support should be calculated on the same basis as which unbundled network elements are made available. This is an idea worthy of further consideration. THE CONSTITUTION The local exchange companies claim that if they are left to recover costs from uncertain sources, such as Call Waiting, or intraLATA long distance, their property is being taken because, in a competitive market they might not be able to sell as much as they need to cover their costs. GTE, pp. 13, 17. Comments of MCI Telecommunications Corporation, February 13, 1998 (hereafter, MCI), pp. 3,4, MCI expresses a similar idea, but does not tie it back to the principle that universal service support claims should be averaged across the same geographic areas that unbundled network elements are offered. The law does not contemplate such insulation from competitive forces; it seeks to create them. Because the law starts from just and reasonable rates and recognizes the multi product nature of the firm, the opposite is the case. There is nothing in the constitution that requires rate rebalancing or a huge universal service fund. Here in Washington, as in most other jurisdictions, “just and reasonable” means utilities are allowed only an opportunity -- not a guarantee -- to recover costs that are used and useful. Prudence is not a guarantee of recovery in the marketplace or under regulation. o Rates that are just and reasonable are required to provide service that is economically efficient. An individual cost element is not the stuff of constitutional takings for utilities. Companies have no claim to imprudent costs, excess profits or double compensation of risk. They can be required to reallocate costs to the services for which they were incurred, particularly where there is unreasonable, excess capacity or unnecessary, excessive functionality. o The new revenue opportunities opened by the Telecom Act to the LECs must be included in any discussion of adequate compensation, especially where those opportunities are related to basic service on either the supply-side (by sharing facilities or costs) or demand-side (by being sold in packages). Utilities commenting in this proceeding, as in most others, cite the Duquesne v. Barasch case to support their claims. I always take pleasure in seeing that citation. The Consumer Federation of America was Amicus in that case and I signed the brief. I remember one thing clearly. The utility lost. The court did not order the return of the millions of dollars of costs it alleged had been illegally taken. Duquesne teaches us the exact opposite of what the LECs claim and the lessons are directly relevant to the access charge reform and universal service proceeding. o Ironically, that case involved a regulatory switch. That is, the state of Pennsylvania had switched from a prudence standard to a used and useful standard, trapping costs that were denied recovery. o The case turned on the observation that the consideration of a specific cost item was inappropriate when the overall return of the utility should be considered. o The disallowance of costs also did not cause the utility severe financial distress and so it stood. I take great heart from Duquesne in the context of the current proceeding. Here we have the utilities trying to cost out the piece parts of the network, trying to ignore other revenues, ignoring a wide range of new revenue opportunities, with bottom lines that are among the fattest in the nation. The will lose this case, too. Imagine GTE before the Duquesne Court, with its 40 percent return on equity achieved by bundling local and long distance service which are provided over joint and common facilities, claiming that its property had been taken because the Commission treated the loop as a common cost or included a reasonable projection of revenues from Call Waiting in estimating the need for a universal services fund. I believe that there is no chance that your refusal to create an excessively large universal service fund or to radically rebalance rates is an unconstitutional taking. PUBLIC POLICY Not only is the LEC view of the network wrong on the economics, wrong on the law, and wrong on the constitution, but it is bad public policy. Viewing the telecommunications network in this fashion destroys the integrative function of universal service policy. Universal service was supposed to be a simple concept of including all -- through support of affordable service in high cost (primarily rural) areas. The LEC view turns it into a witch-hunt -- a search for those who are Aable to pay.@ US West, p. 15, complains that access charges provides subsidies “to keep prices low for all residential customers regardless of their need or the cost of serving them.” Companies who have steadfastly resisted using the telecommunications network for social policy suddenly want to means test the price of service. o Middle income consumers in high cost areas will pay more for telephone service because they do not deserve a subsidy. o Small businesses will pay more because they can pass the cost through to consumers. o A household will pay ten times as much for the second line as it did for the first, because universal service will not apply to the second line. Urban consumers will get a second line for connection to the Internet at $10, while rural customers will pay $150. The information superhighway will be readily available and cheap in urban areas and unaffordable in the countryside. This is the antithesis of universal service policy and it clearly conflicts with policy in the statute that requires: Those in rural, insular, and high cost areas, should have access to telecommunications and information services, including interexchange services and advanced telecommunications and information services, that are reasonably comparable to those services provided in urban areas and that are available at rates that are reasonably comparable to rates charged for similar service in urban areas. 47 USC § 254(b)(3) The only reason I quote at length here is that I could not have said it better myself. The whole effort to restrict universal service to poor people in high cost areas and first residential lines is bad policy and in conflict with the spirit and the letter of the law. PRINCIPLES FOR ACCESS CHARGE REFORM AND UNIVERSAL SERVICE Let me now turn to specific public policy recommendations in light of this integrated view of the network. First, let me assure you that because the local exchange company view of the Telecom Act lacks a legal, constitutional, economic and public policy basis, it has not been adopted anyplace in the country. The LECs will try to bootstrap the 8th Circuit Court decision into claiming that these issues were decided, but the 8th Circuit decision dealt only with jurisdiction over the pricing of network elements. When it came to access charges and universal service, it did not deal with substantive interpretation of the statute in a clear or comprehensive manner. That was left to some future court case, which the LECs are certain to file. In fact, the Federal Communications Commission has rejected the nonsensical view of the network proposed by the LECs and the courts have not reversed its view. It has embraced the concept of forward-looking economic costs (the big constitutional question). It has repeatedly defined the loop as a shared cost (the big economic question). It has included revenues from other services in its calculation of the need for universal service support (the big legal question). It has begun to recognize the possibility of substantial excess capacity and excessive functionality in the network (important economic and constitutional issues). No state that I know of has adopted the LEC's view of the network. Many of them are still in the throes of addressing these questions, as you are here in Washington, but virtually all states treat the loop as a shared cost. Shared costs immediately lead to shared revenues, and those two conclusions solve the major policy problems of universal service facing the Commission here in Washington. o First, treat the network as a multi product undertaking. Treat the loop as one of the shared cost of that undertaking and require all services that use the loop to contribute to those costs. Consider vertical services as part of the enterprise. As noted, TRACER recognizes the loop as a common cost. [Other commentors do not.] In addition to those already noted, see , Additional Comments of Sprint Communications Company L.P. on Behalf of Sprint Corporation, February 13, 1998 (hereafter, Sprint), p. 5. o Second, universal service payments must be based on an efficient network. I do not mean efficient at the embedded cost level, where decades of monopoly inefficiencies are embedded in the cost structure. I do not mean efficient at the cost model level we have recently sunk to, where uneconomic assumptions about network architecture are imposed on the cost estimate to quiet political and legal threats. I mean efficient in a forward looking sense, where, over time, every decision that affects cost will have to stand a direct economic test in the marketplace. Universal service policy will fail miserably if it insulates incumbents from that economic test. o Third, and flowing from the forward looking efficient cost principle, high costs funds should be built up from specific estimates of efficient costs to provide service. Do not make it a residual, make-whole fund. TRACER, p. 2-3. o Fourth, cost recovery should be efficient, where possible. Match costs with cost causers. Match patterns of cost causation with patterns of cost recovery. The shift from usage-based charges to flat-rated charges for the recovery of loop costs is universally supported. Public Counsel supports the creation of a flat-rated carrier charge. Others support flat-rate end user charges. Public Counsel believes that this in effect, allows intraLATA long distance providers to use the loop for free, which violates the prohibition on cross-subsidies. o Fifth, to the extent possible, maximum market pressure should be placed on inefficiencies in current rates. Squeezing these out is the ultimate goal of the entire policy. IMMEDIATE STEPS TOWARD REFORM At a concrete level, there are specific, practical steps the Commission can take to start the process. o First, transform part of the current access charges into a fixed recovery of a fair share of loop costs. I have been on record as advocating a shift from the usage-based recovery of loop costs to more fixed recovery of those costs. I say Amore fixed@ because there are aspects of loop costs that are not as fixed as they seem. When a loop is designed and deployed, the costs are not fixed. They are variable with respect to the services that will utilize the loop. If certain services require higher levels of functionality or capacity in the loop, then they should bear the cost responsibility. Once the loop is deployed there is a tendency to spread the costs around without remembering why the costs were incurred and the loop is used. More importantly, while the costs may be fixed, the revenue opportunity is variable. Different service providers may occupy the loop and thereby exhaust its revenue opportunity. When the primary carriers are asked to pay for a share of the loop, they bristle at the thought that dial-around competitors will avoid that charge. The solution, of course, is that the total amount to be recovered should be fixed, but the burden should be spread according to use. If you keep the contribution fixed and divide by the use, you spread the burden properly. You also avoid the problem in the old pure usage-based system that contribution goes as use increases. Service providers would pay a fixed total amount with the rate declining as usage grows. If you have the guts, make your loop charge a capped per-line amount spread among all the intraLATA carriers who use the line. A simple PICC may be easier. o Second establish a high cost fund of modest size based on a forward-looking model that includes a reasonable projection of all revenues per line. These two steps will alleviate considerable pressure on access charges. o Third, I rather like the idea of taking all of the first reductions from terminating access, since termination is not subject to competition. If you are lucky, you will be able to lower termination to cost and not raise origination. Let the market work on origination. o Fourth, do these things in stages and require a showing that access charge reductions are being passed through to consumers in one stage, before you move on to the next stage. There is a loud enough debate in Washington D.C. about what gets passed through to whom to suggest that market forces alone may not be sufficient to ensure pass-through. Market forces are certainly not even enough across market segments to ensure that the little guy gets a fair share of the reductions. Thus, a regulatory stick should be added to imperfect market forces to ensure fair pass-through. o Fifth, if after the first two rounds there are no signs that market forces are operating to reduce originating access, then another round of regulatory reductions should be undertaken. CONCLUSION In the LEC view of the network the biggest public policy problem has always been the need to raise basic service rates over the objection of residential ratepayers, who do not want to see their local rates go up about $10 per month on a national average basis. This conclusion was and is based on the faulty view of the network as a POTS only enterprise in which none of the common costs