Additional Comments of Commissioner P. Gregory Conlon on the Implementation Rate Design (IRD) Draft Decision I.87-11-033, et al. Although this draft decision is significantly improved in many ways from the previously rescinded decision, I continue to have serious concerns in several areas and ask parties to comment on these concerns when they comment on the draft decision circulated today. GTEC Basic Rates Although basic rates proposed in this draft decision are lower than those adopted in D.93-09-076, I am still very concerned about the high rates for GTEC, and the large differences between Pacific and GTEC rates. Setting GTEC rates too high will make GTEC especially vulnerable when competition is permitted, so I believe GTEC rates should be set reasonably close to Pacific Bell rates. I would like to see GTEC's basic business rate set at $15 per month rather than $16.99 per month. I would also like to see GTEC's residential basic rates reduced by about $1 per month from $17.49 to $16.50 per month. Pacific to GTEC Transfer Payments I also believe that we should continue transfer payments from Pacific to GTEC for two more years in order to moderate GTEC rate increases proposed in this order. I estimate that a 1995 transfer payment of approximately $100 million would be reduced by 1/2 in 1996, and phased out at the end of 1996 I.87-11-033, et al. July 20, 1994 (before we plan to permit open competition). This draft order discontinues the current arrangement of transfer payments because of the belief that each local exchange company (LEC) should recover its costs from its own customers. While I agree with this in principle, I disagree that we must terminate transfer payments immediately. However, an alternative to continuing transfer payments which I am also willing to consider is a company specific surcharge. Like continued transfer payments, this surcharge would mitigate sharp increases in basic rates now by spreading these costs over all GTEC services. This surcharge would also be phased out over the next two years through adjustments to GTEC's annual price cap filings. GTEC currently receives over $150 million per year in transfer payments from Pacific as it terminates its participation in LEC settlement pool arrangements. These payments are entirely eliminated by the rate design contained in today's draft decision. Although Pacific and GTEC have an agreement to terminate these transfer payments over a five year period, the Commission by this draft decision has decided to terminate this arrangement a year earlier than the companies agreed. Since this Commission has adopted a program to lessen regulatory control over company decision making, I don't believe it is appropriate to now step in and unilaterally decide to change an agreement made between these companies. Some believe that GTEC management is responsible for GTEC being a higher cost company than Pacific, and that GTEC must be required to stand on its own under the New Regulatory - 2 - I.87-11-033, et al. July 20, 1994 Framework. However, this belief fails to recognize that GTEC's higher costs may be due to a relatively larger proportion of GTEC's customers being located in higher cost, sparsely populated rural and desert areas. I find inconsistencies in an approach which requires this one LEC to recover all its costs from its own customers, while other LECs serving rural areas should receive support from Pacific through the high cost fund. We are not deregulating GTEC in this rate design, and we are still obligated to see that GTEC has an opportunity to earn a fair return on its investment. I don't believe we should "flash cut" from a system that's been in place for such a long time. There should be an orderly transition which allows utilities to adapt to changing conditions without major financial dislocations to the company, and without drastic increases in customer rates. Carrier Common Line Charge (CCLC) Flow Through Another area where I disagree with the draft decision is whether the revenue reductions caused by the elimination of the Carrier Common Line Charge (CCLC) should be flowed through to end users in lower toll rates. While today's draft decision does not require LECs to flow through this reduction in toll rates, I believe that Pacific Bell and GTEC should. However, I don't believe any IECs should be required to do so, since they would be encouraged to do so voluntarily in order to compete in price with Pacific or GTEC. I believe that unless this flow through is ordered, initially there will not be sufficient competitive pressure to encourage carriers to voluntarily flow through these cost savings - 3 - I.87-11-033, et al. July 20, 1994 in lower rates to customers. Without a required flow through for at least Pacific and GTEC, I believe the elimination of the CCLC will be a windfall for carriers at the expense of ratepayers. I have determined that a revenue neutral rate design can be achieved if the proposals I described above are adopted. Imputation Finally, I also disagree with the draft decision regarding the issue of imputation. This Commission has clearly expressed its desire for cost-based pricing. This preference has been articulated often, specifically in the Phase II decision and more recently in Commissioner Shumway's Assigned Commissioner Ruling which was issued concurrently with last year's proposed decision. To quote from that Ruling, "part of the imperative of opening a market to competition is to assure that rates are based on cost...the policies set forth in this decision must send efficient price signals which promote modernization of network equipment..." and, "the principles of costing properly must universally apply to the rate design to encourage fairness of pricing policies between competitors, and prevent hidden subsidies from some classes of customers to other classes." (July 16, 1993 ACR) I agree with these statements and believe these principles should equally apply when setting minimum prices (price floors) for LEC services containing monopoly functions. I believe price floors should be based on the costs incurred by the LEC providing a given service, and setting price floors on any other basis is contrary to the principle of cost-based pricing. - 4 - I.87-11-033, et al. July 20, 1994 I believe that an imputation method which permits LECs to set price floors which are not based on the monopoly building block used by itself to provide a service, but instead on what a LEC's competitor might use to provide that service is inconsistent with the principle of cost-based pricing so clearly endorsed by this Commission. Put simply, all competitors (including the LECs) should pay for what they use, and all competitors (including the LECs) should pay the same price for monopoly functions available only from the LEC. The imputation policy established in the Phase II decision is the primary safeguard we have to ensure fair competition, and also helps to limit a LEC's ability to cross- subsidize its competitive services with revenues obtained from its captive customers. Phase II established imputation rules to prevent the LEC from providing monopoly building blocks to itself at prices more favorable than could be obtained by others who need that LEC-provided feature to compete. Without this safeguard, the LEC can always under-price equally efficient competitors, and dampen or kill the emergence of effective competition. I believe that the policy articulated in today's draft decision is a significant departure from the policies set in Phase II; policies which were not supposed to be changed in this rate design proceeding. The Phase II decision states, "...in order to prevent anticompetitive price squeezes, the local exchange carriers should be required to impute the tariffed rate of any function deemed to be a monopoly building block in the rates for any bundled tariffed - 5 - I.87-11-033, et al. July 20, 1994 service which includes that monopoly function. (33 2nd CPUC 121) (emphasis added) Permitting a LEC to impute a cost to itself other than that of the monopoly function actually used by the LEC effectively undermines the imputation safeguard, and removes any assurance that the LEC is not "charging itself" less than it charges its competitors for the same monopoly function. Furthermore, it removes any assurance that the LEC is not setting prices below the real cost of the monopoly function actually used. When this happens, other customers and services will be subsidizing the LEC's competitive services. I believe that our imputation rules must require LEC price floors to be based on the imputed rates for functions actually used by the LEC, and not on imputed rates for functions which might be used by competitors. - 6 -