BILL ANALYSIS AB 2958 Page 1 Date of Hearing: April 1, 2002 ASSEMBLY COMMITTEE ON UTILITIES AND COMMERCE Roderick D. Wright, Chair AB 2958 (Wright) - As Introduced: February 25, 2002 SUBJECT : Telecommunications: regulatory framework. SUMMARY : Codifies in statute operative portions of a 1998 decision by the California Public Utilities Commission (PUC) adopting a new regulatory framework program and price adjustment formula for two major incumbent local exchange telephone carriers. Specifically, this bill : 1)Affects SBC-Pacific Bell and Verizon, companies that were subject to the modifications made by PUC to the new regulatory framework (NRF) in Decision 98-10-026. 2)Specifies that any price cap price cap index productivity factor, sharing mechanism, and related elements shall continue to be suspended, consistent with the PUC decision. 3)Provides that 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. 4)Clarifies that the PUC's existing authority to regulate the quality of service provided by telephone corporations shall be preserved. 5)Sunsets on January 1, 2007. 6)Makes various legislative findings with reference to NRF, and to the fact that circumstances exist making this special statute valid because a general law cannot be made applicable. EXISTING LAW : 1)Grants PUC regulatory authority over local telephone corporations. 2)Requires PUC to inspect and audit the books and records of telephone corporations for regulatory and tax purposes at least once every three years. AB 2958 Page 2 FISCAL EFFECT : Unknown. COMMENTS : NRF in general Before 1989, local telephone companies, or incumbent local exchange carriers (ILECs), were regulated under a rate-of-return framework, which in general sets rates based on expenses incurred in providing service, allowing a reasonable profit on the utility's assets that are used to provide the service. In 1989, PUC adopted NRF, an incentive-based regulatory system designed to promote PUC 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. Under NRF, rates are adjusted annually based on a formula that offsets inflation costs against cost decreases due to increased productivity, additionally allowing cost recovery on matters outside the control of the utility ("Z factors"). Category I, II and III Services NRF classifies basic monopoly services like dial tone as Category I services. PUC sets prices for all Category I monopoly services. Category II includes partially competitive and discretionary services. These services 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. Price Cap Index & Productivity Factor NRF contains a price cap index formula, equal to inflation minus a productivity factor, and applicable to Category I and II services. The productivity factor was designed as a substitute for market forces, passing through gains in productivity to customers. In 1995, 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. AB 2958 Page 3 Sharing NRF contains an earnings-sharing mechanism, which includes a benchmark, ceiling and floor rate of return. ILECs retain 100% of earnings up to the benchmark, but return earnings at varying percentages to ratepayers for earnings above the ceiling rate of return. The PUC decision regarding SBC-PacBell and Verizon In the 1998 decision established as the NRF benchmark of AB 2958, PUC ordered continuing suspension of the price cap index and productivity factor previously suspended in 1995, and suspended sharing for Pacific Bell and Verizon. PUC found that continuing the suspension of price caps and the productivity factor would advance the goals of NRF (outlined above)and would produce rates that are just and reasonable. PUC noted that suspension does not eliminate PUC authority over, or remove, rate caps, floors or ceilings on Category I and II services. In the decision, PUC suspended sharing for PacBell and Verizon 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. PUC also voiced concern about asymmetric application of sharing; giving potential competitors an ability to make investment decisions without similarly imposed profit constraints. Return to rate of return? Sponsors and supporters contend that recent actions by PUC and the Office of Ratepayer Advocates (ORA) indicate an institutional desire to return to a system in which earnings are capped, either by way of rate of return regulation or through a price index and sharing mechanism. According to the sponsor and supporters, these activities have already created measurable doubt as to the wisdom of continuing the current level of investment in California technology and information infrastructure because of the risk that future investment will not be recouped in a manner or timeframe that will ensure financial health of the companies. AB 2958 Page 4 ORA contends that this measure would not allow PUC to conduct a full review of PacBell or Verizon. ORA objects to "freezing" of NRF, thereby removing PUC's authority to reinstate earnings sharing or to adjust price cap productivity index. Audit PUC recently announced completion of a Section 314.5 triennial audit of Pacific Bell, covering the years 1997 through 1999. The audit recommends customer refunds of almost $350 million for the years 1997 and 1998, consistent with the sharing mechanism in place during the relevant time. PUC intends to review the audit report in a formal proceeding, during which Pacific Bell and interested parties will have an opportunity to be heard on the audit findings. AB 2958 does not affect the audit review process, including the adjudication of whether or not refunds in the form of sharing are due to consumers. Related Legislation AB 2898 (Pescetti) requires any price cap index mechanism previously suspended by PUC in regulating a telephone corporation shall be suspended until 2007. AB 2898 also suspends sharing under NRF until January 1, 2007. REGISTERED SUPPORT / OPPOSITION : Support SBC-Pacific Bell (sponsor) Advanced Fibre Communications Applied Materials California Business Roundtable (co-sponsor) California Chamber of Commerce (co-sponsor) California Hispanic Chambers of Commerce California Manufacturers & Technology Association (co-sponsor) California Small Business Association California Telecommunications Association Communication Workers of America Congress of California Seniors Consumers First Diamond Gateway Chamber of Commerce AB 2958 Page 5 Greater Los Angeles African-American Chamber of Commerce Intel NAACP Sacramento Chapter Pat Brown Public Policy Institute Sacramento Central Labor Council AFL-CIO San Diego Regional Chamber of Commerce San Jose Silicon Valley Chamber of Commerce Silicon Valley Manufacturing Group Verizon G. Mitchell Wilk, former PUC Commissioner Opposition California Public Utilities Commission Consumers Union MCI WorldCom Office of Ratepayer Advocates TURN Analysis Prepared by : Paul Donahue / U. & C. / (916) 319-2083