BILL ANALYSIS AB 2898 Page 1 Date of Hearing: April 24, 2002 ASSEMBLY COMMITTEE ON APPROPRIATIONS Darrell Steinberg, Chair AB 2898 (Pescetti) - As Amended: April 4, 2002 Policy Committee: Utilities and Commerce Vote: 13-0 Urgency: No State Mandated Local Program: No Reimbursable: SUMMARY This bill codifies operative portions of a 1998 Public Utilities Commission (PUC) decision regarding telecommunications regulation-specifically the new regulatory framework (NRF) and price adjustment formulas. This bill: 1)Specifies that any price cap index productivity factor, sharing mechanism, and related elements shall continue to be suspended, consistent with the PUC decision. 2)Provides that the PUC shall maintain authority to regulate prices for all services subject to its jurisdiction, and shall continue to have authority to move service between all pricing categories. 3)Applies the above to every telephone company regulated by the PUC pursuant to the NRF. (This would apply to four telephone companies-SBC-Pacific Bell, Verizon, Citizens, and Surewest.) 4)Sunsets these provisions in January 2007. FISCAL EFFECT Potential savings to the PUC from avoided proceedings that might otherwise be undertaken regarding the regulatory elements suspended in its 1998 decision. [The PUC, for a similar bill (AB 2958, Wright) has estimated costs of about $1.4 million for 14 new positions to develop an alternative regulatory tools-in lieu of those being suspended in the bill- to ensure just and reasonable telephone rates. AB 2898 Page 2 However, by freezing the existing regulatory scheme with respect to certain elements of NRF, AB 2898, in and of itself, does not impose additional workload on the PUC. The commission's cost estimate is based on how the commission might choose to respond based on the results of a future audit of the company or companies. Moreover, should the commission choose to modify NRF regulation, it would have to justify any request for additional staff for this purpose through the budget process given the commission's existing regulatory staff and workload.] COMMENTS 1)Background. Before 1989, local telephone companies were regulated under a rate-of-return framework. In 1989, the PUC adopted a new regulatory framework of "price-cap regulation"-a system whereby phone rates are adjusted annually based on a formula that accounts for inflationary cost increases and cost decreases from increased productivity. The NRF was intended to promote the PUC's goals of universal service, economic efficiency, technological advancement, rate stability, full utilization of the local exchange network, and avoidance of cross-subsidies and anti-competitive behavior. Category I, II, and III Services. NRF classifies basic monopoly services, like dial tone, as Category I services, and the PUC sets prices for these services. Category II includes partially competitive and discretionary services, which have price ceilings and floors approved by PUC, and the regulated entity is free to adjust price in between. Utilities are allowed maximum pricing flexibility for Category III, or fully competitive, services. NRF contains a price cap index formula, equal to inflation minus a productivity factor, applicable to Category I and II services. Sharing. NRF also contains an earnings-sharing mechanism, which includes a benchmark, ceiling and floor rate of return. Telephone companies retain 100 percent of earnings up to the benchmark, but return earnings at varying percentages to ratepayers for earnings above the ceiling rate of return. 2)PUC Decision . In 1995, the PUC suspended the price cap index and productivity factor on the belief that the market was evolving and that market conditions did not warrant continued application of the formula. In a 1998 decision affecting Pacific Bell and Verizon, the PUC ordered continued suspension AB 2898 Page 3 of the price cap index and productivity factor based on a finding that this would advance the goals of NRF and produce just and reasonable rates. In this decision, the PUC also suspended sharing on the belief that sharing distorts operating and investment decisions because it changes the forecast of present and future cash flows, and introduces uncertainty into the stream of returns. The PUC also voiced concern about the asymmetric application of sharing, giving potential competitors an ability to make investment decisions without similarly imposed profit constraints. The PUC noted that the above suspensions do not eliminate its authority over rate caps, floors, or ceilings on Category I or II services. 3)Purpose . AB 2958 (Wright), also on today's committee agenda, provides that the 1998 PUC decision involving SBC Pacific Bell and Verizon shall remain in effect until 2007, but is applicable only to those two entities. AB 2898 differs from AB 2958 in that it applies the suspension of the price cap productivity factor and sharing articulated by PUC in the Pacific Bell-Verizon NRF decision to each telephone company regulated pursuant to NRF, thus making it also apply to the two other NRF-regulated telecommunications companies-Surewest Communications (formerly Roseville Communications) and Citizens Communications. In 2001, the PUC reviewed Surewest's NRF structure and, among other things, ordered the retention of its sharing mechanism. In Rulemaking 01-09-001, the PUC is considering whether to eliminate the sharing mechanism, continue the suspension of the sharing mechanism, or to reinstate the sharing mechanism. Supporters note that AB 2898 will enable Surewest and Citizens to be on the same regulatory footing as Pacific Bell and Verizon. 4)Opposition . The PUC states that, among other things, AB 2898 reverses recent PUC orders continuing sharing for Surewest, and remains convinced of the correctness of its prior decisions. Analysis Prepared by : Chuck Nicol / APPR. / (916) 319-2081