BEFORE THE WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION In the Matter of ) Determining Costs for ) Docket No. UT-980311(a) Universal Service ) ) POST-HEARING BRIEF OF NEXTLINK WASHINGTON, INC. October 7, 1998 TABLE OF CONTENTS Page I. INTRODUCTION 1 II. LEGAL PRINCIPLES 2 A. State Law 2 1. Ch. 337, L. 1998 2 2. Relationship Between This Docket and Other Dockets 2 a. Can or should the Commission take any action on universal service absent an explicit directive from the legislature? 4 b. Need for consistency between the universal service fund proceeding and the price of unbundled network elements 5 (1) If the rates and the USF must be consistent, does this imply that UNE rates must be deaveraged? 7 (2) & (3) If there is a need to deaverage UNE prices, must this be done prior to the legislature taking action on the USF issue? If the legislature takes no action on the Commission's report, is there a need to deaverage UNEs? 9 B. Federal Law 11 IX. CONCLUSIONS AND RECOMMENDATIONS 11 NEXTLINK POST-HEARING BRIEF - 1 38936\22\00132.BRF/9.8.98 Seattle I. INTRODUCTION The Commission has a daunting task before it -- to synthesize an enormous amount of cost data and other information into a report and recommendation to the legislature on the reform of universal service support. In the midst of completing that task, however, the Commission should understand both the genesis and the impact of its determination in this proceeding. Any need for universal service support reform will arise only when local exchange competition begins to erode existing implicit subsidies currently used to recover the costs U S WEST Communications ("U S WEST") and GTE Northwest Incorporated ("GTE") incur to serve less densely populated areas of Washington. That day has not yet arrived, nor is it likely to arrive in the near future as long as the rates U S WEST and GTE charge competing local exchange carriers ("CLECs") for unbundled network elements ("UNEs") are based on statewide geographically averaged costs. NEXTLINK Washington, Inc. ("NEXTLINK") is a CLEC that provides local exchange service in competition with U S WEST in Spokane and anticipates offering service in the Seattle metropolitan area. Proper costing and pricing signals are critical to NEXTLINK's ability to serve customers efficiently and to offer competitive choice to the largest possible number of Washington consumers. Such signals include the size of any universal service support fund, carriers' contributions to the fund, and amounts available for withdrawal from the fund. More important for NEXTLINK and other CLECs, however, are the signals sent by the prices they must pay to the incumbent local exchange carriers ("ILECs") for UNEs --particularly unbundled loops -- and the extent to which those prices are based solely on the forward-looking cost to provide those elements and whether those prices also includes implicit subsidies to other ILEC services. The only signal worse than uncertainty is that provision of service using UNEs is not economically viable and only companies willing and able to construct virtually every part of their own networks can provide competitive services. Statewide geographically averaged UNE rates send just such signals. As long as those signals persist, the Commission's efforts to reform universal service funding will be unnecessary, because effective competition will not develop and no explicit universal service fund will be needed. II. LEGAL PRINCIPLES A. State Law 1. Ch. 337, L. 1998 NEXTLINK addresses the legislature's requirements in Ch. 337, L. 1998, to the extent necessary as part of the issues discussed below. 2. Relationship Between This Docket and Other Dockets One of the Commission's most difficult responsibilities in facilitating the development of local exchange competition is to manage the interrelationship of the various aspects of the transition from traditional monopoly to multi-carrier environment. The establishment of separate dockets -- as well as phases within each docket -- may be necessary to deal with the myriad issues the Commission must resolve, but the Commission should resist the natural inclination to view those issues in the isolation of individual dockets. Commission decisions in one docket will likely have a significant impact on the issues in other dockets, as well as on when, and the extent to which, consumers will be able to enjoy the benefits of an effectively competitive market. This docket typifies the Commission's dilemma. The need for universal service reform derives solely from the advent of local exchange competition, yet all the available evidence indicates that such competition has scarcely begun to emerge in Washington. The Commission has yet to establish rates for UNEs in Docket Nos. UT-960369, et al., and, not surprisingly, U S WEST has yet to provide unbundled loops in Washington. See Tr. at 1824 (NEXTLINK Knowles Cross). Collocation is critical to the development of facilities-based local exchange competition, see Tr. at 1792 (PC Johnson Cross), but the Commission has yet to establish collocation rates in Docket Nos. UT-960369, et al., or finally to resolve disputes over collocation space in at least one U S WEST central office in Docket Nos. UT-960323, et al. The absence of any docket in which U S WEST, GTE, or Sprint United has sought to adjust their retail rates to respond to competitive pressure (or in which U S WEST has requested authority to offer interLATA services pursuant to 47 U.S.C. § 271) speaks volumes on the minimal inroads that competitors have made into the incumbents' monopoly service territories -- and, correspondingly, the lack of any urgency to reform universal service funding and support. The Commission obviously must respond to the legislature's requirement for a report on universal service reform. That response, however, must be tempered with the recognition that much work remains to be done in pending and yet-to-be-initiated dockets to open Washington's local exchange markets. Until that work is completed -- and completed in a manner that will result in the development of effective competition -- no legitimate need for universal service reform will arise. See Tr. at 1791-93 (PC Johnson Cross); Tr. at 1702-05 (AT&T Baker Cross). a. Can or should the Commission take any action on universal service absent an explicit directive from the legislature? Washington courts have limited the Commission's authority to those activities expressly granted by the legislature or necessarily implied in a legislative grant. In re Consolidated Cases, 123 Wn.2d 530, 536-37, 869 P.2d 1045 (1994). More specifically, the Commission cannot "tax" or otherwise require carriers or end-users to pay surcharges that will be used to fund a program to benefit selected carriers without legislative authority. WITA v. TRACER, 75 Wn. App. 356, 880 P.2d 50 (1994). The legislature has implicitly recognized this limitation -- and its applicability to universal service reform -- by requesting a report from the Commission in anticipation of legislative action on this issue. Until the legislature provides the Commission with express authority to restructure funding and support payments for universal service purposes, therefore, the Commission cannot and should not take any formal action on these issues. Such restraint necessarily includes refusing to permit an incumbent LEC to impose so-called "interim universal service surcharges" on competitors, such as GTE has proposed in this docket (and in Docket Nos. UT-960369, et al.). No state or federal law either authorizes such surcharges or authorizes the Commission to allow incumbent LECs to impose such surcharges. To the contrary, the Act's pricing standards require that all charges an incumbent LEC may charge competitors must be based on avoided costs (resale), forward-looking costs of provisioning plus a "reasonable profit" (interconnection and UNEs), or additional costs (transport and termination of traffic), and such costs (except resale) must be determined "without reference to a rate-of-return or other rate-based proceeding" that establishes and quantifies implicit universal service or other subsidies. 47 U.S.C. § 252(d). Pending legislative authority to reform universal service support, a rate case is the only avenue available to GTE or any other incumbent LEC that believes competitive losses render the company unable to fulfill its universal service obligations or otherwise earn its authorized rate of return. b. Need for consistency between the universal service fund proceeding and the price of unbundled network elements "Competitive neutrality requires that the costs of local service -- whether calculated as a whole for universal service purposes or in its component parts as UNEs provided to competitors -- be estimated using the same methodology." Ex. 401 (NEXTLINK Knowles Response) at 5. The FCC has expressly adopted the principle of competitive neutrality for federal universal service support mechanisms and rules and defines that term to mean that "universal service support mechanisms and rules neither unfairly advantage nor disadvantage one provider over another . . . ." In re Federal-State Joint Board on Universal Service, CC Docket No. 96-45, FCC 97-157, Report and Order ¶ 47 (May 8, 1997) ("Universal Service Order"). The FCC further required the use of forward-looking economic costs to estimate federal universal service support, id. ¶ 26, and urged states to use the same methodology for calculating both universal service support and UNE rates: We also encourage a state, to the extent possible and consistent with the above-criteria, to use its ongoing proceedings to develop permanent unbundled network element prices as a basis for its universal service cost study. This would reduce duplication and diminish arbitrage opportunities that might arise from inconsistencies between the methodologies for setting unbundled network element prices and for determining universal service support levels. In particular, we wish to avoid situations in which, because of different methodologies used for pricing unbundled network elements and determining universal service support, a carrier could receive support for the provision of universal service that differs from the rate it pays to acquire access to the unbundled network elements needed to provide universal service. Consequently, to prevent differences between the pricing of unbundled network elements and the determination of universal service support, we urge states to coordinate the development of cost studies for the pricing of unbundled network elements and the determination of universal service support. Id. ¶ 251 (emphasis added and footnote omitted). The Act, moreover, requires that state regulations be consistent with FCC universal service rules and that "[e]very telecommunications carrier that provides intrastate telecommunications services shall contribute on an equitable and nondiscriminatory basis . . . to the preservation and advancement of universal service in the State." 47 U.S.C. § 254(f) (emphasis added). The Commission has required the use of forward-looking economic costs as the basis for both the calculation of universal service support estimates for U S WEST and GTE in this docket and for pricing UNEs in the generic costing and pricing proceeding. Notice of Prehearing Conference (May 15, 1998) at 2; Docket No. UT-960369, et al., Eighth Supp. Order at 8. The Parties in both proceedings have submitted the Hatfield and BCPM models for use in estimating such costs, facilitating the Commission's ability to use a consistent methodology to estimate UNE and universal service costs. Accordingly, the Commission should follow the FCC's guidance and use the same methodology to determine universal service support costs and UNE rates. NEXTLINK joins TRACER in recommending that the Commission establish the cost of basic local exchange telecommunications service provided by U S WEST and GTE for universal service support calculation purposes as the sum of component UNEs and reasonable, forward-looking retail costs. Ex. 401 (NEXTLINK Knowles Response) at 6; Ex. 271 (TRACER Zepp Direct) at 7. (1) If the rates and the USF must be consistent, does this imply that UNEs must be deaveraged? Use of a consistent costing methodology requires that the costs of both universal service support and UNEs be geographically deaveraged. The FCC has specifically required that state cost models submitted to the FCC for determining federal universal service support, at a minimum, "must deaverage support calculations to the wire center serving area." Universal Service Order ¶ 250(10). Indeed, the Commission cannot estimate the costs of universal service support without deaveraging local service costs, and unless UNE rates are also deaveraged, the Commission will create the very arbitrage opportunities that underlie the FCC's recommendation that state commissions use the same methodology for costing universal service support and UNEs. A greater problem than arbitrage -- in light of the greater likelihood that competitors will be obtaining loops in urban, low cost areas, rather than in high cost areas eligible for universal support -- is the unavoidable distortion and windfall distribution of universal service support to U S WEST and GTE if UNEs are not geographically deaveraged. As Mr. Knowles explained, Failure to address geographic deaveraging of loop costs will artificially inflate the size of the fund needed to provide universal service support. Most, if not all, loops the CLECs obtain from ILECs, at least initially, are likely to be in the most densely populated geographic areas where the loop costs are the lowest. Indeed, Hatfield Model cost estimates in six of the nine geographic areas in Washington are significantly lower than the $17.00 statewide averaged loop cost found by the Commission in its Eighth Supplemental Order in Docket Nos. UT-960369, et al. If CLECs are paying a statewide averaged loop rate that is substantially higher than the cost of the loops they obtain, the ILECs will be recovering the difference as an implicit subsidy in addition to the explicit universal service support to which they are otherwise entitled. The CLECs and their customers, moreover, will be compelled to pay more than their "equitable and nondiscriminatory contribution to the preservation and advancement of universal service" as required by Section 254(b)(4) of the Act. Ex. 401 (NEXTLINK Knowles Response) at 12 (emphasis added). U S WEST may attempt to refute this concern by claiming that U S WEST's element "costs" are its embedded costs, that U S WEST does not internally account or "pay" for loops and other network elements on a geographically deaveraged basis, and that therefore U S WEST and its competitors are paying the same costs for network elements. See Tr. at 1698-99 (AT&T Baker Cross). The logical consequence of that position, however, is that U S WEST would not be entitled to any explicit universal service funding because it incurs only a single, statewide average cost of service and U S WEST, by its own admission, thus does not serve "high cost" areas eligible for support. See Tr. at 1680-81 (AT&T Baker Cross). If U S WEST and GTE claim eligibility for any universal service fund support, they must concede that their costs for loops and the other network elements that comprise their basic local service offerings vary by geographic area. Accordingly, making the current implicit geographic cross subsidies explicit as part of a universal service fund requires that UNEs --like the costs of basic local telecommunications service -- be geographically deaveraged. See 47 U.S.C. § 254(f). (2) & (3) If there is a need to deaverage UNE prices, must this be done prior to the legislature taking action on the USF issue? If the legislature takes no action on the Commission's report, is there a need to deaverage UNEs? The need to deaverage UNE prices is immediate and is driven primarily by legal requirements and pro-competition policy concerns, not by any legislative action taken or not taken on USF issues. The Act requires that UNE rates must be nondiscriminatory and "based on the cost (determined without reference to a rate-of-return or other rate-based proceeding) of providing the . . . network element." 47 U.S.C. § 252(d)(1). The cost of providing an unbundled loop in Seattle is the forward-looking cost U S WEST would incur to construct the loop in Seattle, not in some other part of the state or throughout the state. Any decision by U S WEST not to account for loop construction costs on a geographically deaveraged basis is a result of rate-of-return ratemaking, not cost causation. The cost models submitted in this proceeding indisputably indicate that U S WEST incurs loop and other network element costs on a geographically deaveraged basis. Statewide averaged loop rates imposed on competitors, therefore, are neither nondiscriminatory nor based on U S WEST's costs to provide the element. See Tr. at 1823-24 (NEXTLINK Knowles Cross). The Act's requirements notwithstanding, geographically averaged UNE rates represent a major barrier to the development of effective local exchange competition in Washington. Simple economics counsel competitors not to purchase a loop from U S WEST in Seattle based on a statewide averaged cost of $16.25 when that rate is almost three times higher than the cost U S WEST incurs to construct that loop. See Ex. 401 (NEXTLINK Knowles Response) at 8. If a CLEC can construct that same loop for $10, the CLEC will likely do so if it needs to serve a particular customer, but that decision has at least three negative impacts. First, the CLEC will incur greater expense and more time to construct the loop itself than to obtain an existing loop from the incumbent, inhibiting the CLEC's ability -- and providing a disincentive -- to serve customers not already connected to its network, as well as further delaying the availability of competitive choice to more Washington consumers. Second, the CLEC is compelled to use limited capital to construct loops when it should be able to obtain loops from the incumbent at a lower cost, again undermining the CLEC's ability to efficiently and effectively expand its network to offer its services to a larger population of potential customers. Third, when loop rates eventually are geographically deaveraged, the CLEC has a sunk loop investment at a $10 monthly cost that is significantly higher than the $5.59 geographically deaveraged cost, placing the CLEC at a competitive disadvantage to both the incumbent and other competitors. The Commission nevertheless has postponed consideration of geographically deaveraged UNE costing and pricing, and the practical effect of that decision is to undermine past Commission efforts to open Washington's local exchange markets. The Commission should carefully consider the path it takes. If the Commission's sole interest is a properly established and explicit universal service fund, the Commission should not wait until the legislature acts to begin to take steps to deaverage UNE rates to ensure consistency between those rates and universal service support. If the Commission also wants to continue its historic practice of doing what it can to facilitate and maximize the availability of an effective choice of local service provider for Washington consumers, the Commission should immediately establish geographically deaveraged UNE rates. B. Federal Law The federal law on which NEXTLINK relies to support its position is discussed in conjunction with the issues addressed above. IX. CONCLUSIONS AND RECOMMENDATIONS The Commission cannot lose sight of the complementary goals of this proceeding: to estimate the costs of basic local service and quantify the need for universal service support in high-cost areas, while ensuring competitive neutrality and maximizing the opportunities of efficient providers to enter markets throughout Washington and bring the benefits of competition to consumers. The Commission need not even address universal service reform if it does not foster the development of effective local exchange competition. The Commission, therefore, should pursue both goals by (1) estimating costs for basic local exchange telecommunications service that are consistent with the costs established for the UNEs that comprise that service, and (2) removing implicit subsidies in UNE costs by geographically deaveraging those costs, in particular the cost of the unbundled loop. DATED this 7th day of October, 1998. Davis Wright Tremaine LLP Attorneys for NEXTLINK Washington, Inc. By Gregory J. Kopta WSBA No. 20519