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Ottawa, 31 October 1995
Telecom Decision CRTC 95-21
IMPLEMENTATION OF REGULATORY FRAMEWORK - SPLITTING OF THE RATE BASE AND RELATED ISSUES
Table of Contents Page
I INTRODUCTION 1
II BENCHMARKING 6
III LOCAL EXCHANGE COST OPTIMIZATION MODEL 19
IV RATE REBALANCING 21
V PRICE CAPS 27
VI BROADBAND 30
VII SPLIT RATE BASE 41
VIII CONTRIBUTION 72
ATTACHMENT A 82
ATTACHMENT B 83
ATTACHMENT C 85
Ottawa, 31 October 1995
Telecom Decision CRTC 95-21
IMPLEMENTATION OF REGULATORY FRAMEWORK - SPLITTING OF THE RATE BASE AND RELATED ISSUES
Before a panel comprised of Commissioners David Colville (chairman of the hearing), Fernand Bélisle, Yves Dupras, Peter Senchuk, and Andrée Wylie.
In Review of Regulatory Framework, Telecom Decision CRTC 94-19, 16 September 1994 (Decision 94-19), the Commission determined that the regulatory framework for those Stentor Resource Centre Inc. (Stentor) member telephone companies, that were subject to the Decision, should be modified to respond to the evolving nature of the telecommunications industry due to technological change, competition and industry convergence. Accordingly, consistent with the objectives set out in section 7 of the Telecommunications Act (the Act), the Commission established in the Decision a new regulatory framework that places greater reliance on market forces and seeks to ensure that regulation, where required, is effective.
In Decision 94-19, the Commission required that the rate bases of AGT Limited (AGT), BC TEL, Bell Canada (Bell), The Island Telephone Company Limited (Island Tel), Maritime Tel & Tel Limited (MT&T), The New Brunswick Telephone Company Limited (NBTel) and Newfoundland Telephone Company Limited (Newfoundland Tel) would be split into Competitive and Utility segments, effective 1 January 1995. In addition, the Commission determined that traditional earnings regulation would be replaced with price cap regulation, effective 1 January 1998. Towards that end the Commission established a transitional period during which it will move towards the implementation of price cap regulation for the Utility segment. The Commission also concluded that, unless rates were brought closer to costs, the price cap regime would have to retain many elements of rate of return regulation in order to establish contribution rates. For this and other reasons, the Commission established a program whereby, over the transitional period, local rate increases would be implemented, with offsetting decreases in basic toll rates.
In Decision 94-19, the Commission directed Manitoba Telephone System (Manitoba Tel) to provide comments as to which aspects of the framework set out in Decision 94-19 should not apply to it. By letter dated 28 September 1994, Manitoba Tel stated its view that all provisions of Decision 94-19 should apply to the company.
On 1 November 1994, the Commission issued Implementation of Regulatory Framework - Split Rate Base, 1995 Contribution Charges, Broadband Initiatives and Related Matters, Telecom Public Notice CRTC 94-52, (Public Notice 94-52), initiating a proceeding to implement the splitting of the rate bases of all of the above-noted telephone companies and to establish final contribution charges for 1995. The Commission stated that it would also examine the telephone companies' broadband initiatives, including the Stentor Beacon Initiative, which entails a substantial investment in broadband facilities in order to ensure that Utility segment subscribers do not bear the risk associated with this investment.
On 7 December 1994, the Commission issued Implementation of Regulatory Framework - Stentor Broadband Initiatives and Canada/U.S. Cost Comparisons, Telecom Public Notice CRTC 94-56 (Public Notice 94-56), expanding the scope of the proceeding initiated by Public Notice 94-52 to include a consideration of Canada/United States (U.S.) cost comparisons (i.e., benchmarking), based on requests by Sprint Canada Inc. (Sprint Canada) and Unitel Communications Inc. (Unitel). In addition, the applicable procedure was revised to permit an oral public hearing to deal with issues related to cost comparisons and to telephone company broadband initiatives.
In Order-in-Council P.C. 1994-2036, 13 December 1994 (Order-in-Council 1994-2036), the Governor in Council referred back to the Commission for reconsideration that portion of Decision 94-19 pursuant to which the Stentor members subject to the Decision were to file tariff revisions providing for local rate increases and offsetting basic toll rate decreases. Pending this reconsideration, the Governor in Council stayed the tariff revisions which would have taken effect 1 January 1995. The Governor in Council stated that he considered it material to the Commission's reconsideration of the relevant portion of Decision 94-19 that the Commission compare Phase III cost allocations with external benchmarks. The Governor in Council specified that the Commission's reconsideration should be completed by 31 October 1995.
In light of the above, the Commission issued Implementation of Regulatory Framework - Issues Related to Manitoba Telephone System and Reconsideration of Rate Rebalancing, Telecom Public Notice CRTC 94-58, 29 December 1994 (Public Notice 94-58), which expanded the scope of the proceeding initiated by Public Notice 94-52, as amended by Public Notice 94-56, to include a reconsideration of that portion of Decision 94-19 referred back to the Commission in Order-in-Council 1994-2036. In addition, in Public Notice 94-58, the Commission stated that, in light of concerns expressed by various parties, it would also include in the expanded proceeding a consideration of the application of Decision 94-19 to Manitoba Tel.
Due to the expanded scope of the proceeding, the Commission decided that all issues raised in Public Notices 94-52, 94-56 and 94-58 could be raised at the oral hearing by the Commission or by parties.
The oral hearing took place over the period 8 May 1995 to 16 June 1995. The following parties were present or represented at the hearing, or filed argument: ACC Long Distance Ltd. (ACC), CAM-NET Communications Inc. (Cam-Net) and Westel Telecommunications Ltd. (collectively, ACC et al.); AGT; Alberta Consumers' Coalition (AltaCC); Allarcom Pay Television Limited; BC TEL; the British Columbia Public Interest Advocacy Centre on behalf of the B.C. Old Age Pensioners' Organization, the Council of Senior Citizens' Organizations, the Federated Anti-Poverty Groups of B.C., the Senior Citizens' Association, the WestEnd Seniors' Network and Local 1-217 IWA Seniors (BCOAPO et al.); The City of Calgary (Calgary); Canadian Association of Broadcasters; Canadian Business Telecommunications Alliance (CBTA); Canadian Cable Television Association (CCTA); Canadian Federation of Independent Business; CF Cable TV Inc.; Cogeco Cable Canada Inc.; Consumers' Association of Canada (CAC); Consumers Association of Canada (Manitoba Inc.) and the Manitoba Society of Seniors Inc. (CAC/MSOS); Consumer Policy Institute (CPI); Fédération Nationale des Associations de Consommateurs du Québec and the National Anti-Poverty Organization (FNACQ/NAPO); fONOROLA Inc. (fONOROLA); Mr. Carlyle Gilmour; Government of Quebec; London Telecom Network; Manitoba Tel; NBTel; The New Brunswick Cable Television Association; Québec-Téléphone; Rogers Cable T.V. Limited; Sprint Canada; Stentor on behalf of AGT, BC TEL, Bell, Island Tel, Manitoba Tel, MT&T, NBTel and Newfoundland Tel; and Unitel.
Examination of the witnesses was followed by the presentation of oral final argument. Parties were also given the option of filing written final argument. Final written argument was filed on 19 June 1995 and reply argument was filed on 27 June 1995.
B. Objectives of Decision 94-19
In Decision 94-19, the Commission found that, in the face of rapidly developing technologies and applications, a new regulatory framework was necessary to allow carriers to provide all Canadians ubiquitous and affordable access to an increasing range of competitively provided basic and advanced information and communications products and services to serve increasingly diverse user requirements. The Commission stated that, in the dynamic environment of the telecommunications industry, regulation should encourage, rather than impede, the provision of efficient, innovative and affordable services, and should be flexible and responsive to change.
While the regulatory framework established in Decision 94-19 places greater reliance on market forces, the Commission recognized that regulation is still required in certain areas. In particular, it is essential to ensure that service is affordable where market forces are not effective, and to address issues of undue preference and unjust discrimination that may arise, in part, due to the vertically integrated nature of the telephone companies and their dominance in some markets.
The regulatory framework, as set out in Decision 94-19, was based on a number of interrelated initiatives which, taken as a package, are designed to achieve the objectives described therein. These major initiatives include: (1) splitting the rate bases of the telephone companies into Utility and Competitive segments, (2) the implementation of a Carrier Access Tariff (CAT) to provide for the recovery by the Utility segment (from the Competitive segment and from competitors) of charges for contribution, bottleneck services and start-up costs, (3) the price imputation test (as modified in Decision 94-19), which ensures the telephone companies' rates are not anti-competitive, (4) staged preset local rate increases to be offset by reductions in basic toll rates (rate rebalancing), (5) the move to price cap regulation for the Utility segment after a transitional period, and (6) the direction to the telephone companies to file tariffs regarding co-location and the unbundling of bottleneck services to allow for local competition.
The above-noted initiatives were intended to increase flexibility for the telephone companies, while removing barriers to entry and adopting conditions to safeguard competition. The splitting of the rate base into the Utility and Competitive segments, in conjunction with the CAT and the price imputation test (as modified in Decision 94-19), breaks the link between toll rate decreases and local rate increases, permitting the Commission to focus its efforts more on monopoly and near-monopoly markets, where competitive forces cannot be relied on to discipline the market place, and on access to bottleneck services.
The specific rate rebalancing program set out in Decision 94-19 was designed to take into account various considerations. The Commission expressed the view that rate rebalancing was necessary if Canadians were to benefit fully from increased competition and if bypass opportunities and the potential for uneconomic entry were to be reduced. The Commission considered that rate rebalancing would foster the establishment of conditions necessary to ensure sustainable competition in all Canadian telecommunications markets through pricing policies that provide incentives to users and service providers to conduct their business over Canadian networks. In addition, a closer alignment of rates towards costs would stimulate the development of competition in the local market.
The Commission was also of the view that meaningful regulatory reform could not be undertaken without a significant reduction in the subsidy that users of long distance services are currently providing in order to keep rates for local/access services low. Specifically, as indicated above, the Commission considered that, unless rates were brought closer to costs, the new regulatory framework would have to retain many elements of rate of return regulation in order to establish the level of the subsidies required (contribution rates). In addition, rate rebalancing was necessary, for example, to increase equity for those users who were bearing the burden of a subsidy that is larger than required to achieve universal service objectives.
The Commission's conclusions on issues in this proceeding are set out in the sections below. In reaching its conclusions, the Commission has borne in mind the objectives of Decision 94-19 as discussed above, as well as the submissions of parties and the directions in Order-in-Council 1994-2036.
A. Canada/U.S. Cost Comparisons
In the proceeding leading to Decision 94-19, Unitel introduced exhibits derived from U.S. consulting reports and Phase III results (the Unitel exhibits) which were intended to call into question Phase III assignments and to suggest that Canadian toll costs were considerably understated when compared to U.S. costs. The Unitel exhibits showed the toll costs of AT&T Communications (AT&T-C) at 19.5 Canadian cents per minute and Bell at 9.4 cents per minute for the year 1992.
In Decision 94-19, the Commission noted that while a full examination of the cost differences had not been possible, it did not discount the value of properly documented and tested evidence with respect to Canada/U.S. cost comparisons in future proceedings.
In their petitions to the Governor in Council requesting that Decision 94-19 be reviewed, the Competitive Telecommunications Association and People For Affordable Telephone Service included the Unitel exhibits. Subsequently, by Order-in-Council 1994-2036, the Commission was directed to compare Phase III cost allocations with external benchmarks.
In the evidence submitted in this proceeding as to Canada/U.S. cost comparisons, particularly information relating to U.S. costs, parties relied for the most part on publicly available information. Parties made adjustments to this information in an attempt to align Canadian and U.S. financial data on a comparable basis.
2. Evidence Used for Benchmarking Analysis
In their January 1995 evidence, Unitel and Sprint Canada submitted an average U.S. cost per minute based on an average of AT&T-C, MCI Communications Corporation Inc. (MCI) and Sprint Corporation (Sprint U.S.) toll costs. Unitel compared this average U.S. cost per minute to an average Canadian cost based on Phase III toll costs per minute for Bell, BC TEL and AGT. Sprint Canada, on the other hand, compared its average U.S. cost per minute to Bell's Phase III toll cost per minute. Stentor compared the Canadian Phase III toll cost per minute for Bell and AGT on an individual basis to an AT&T-C toll cost per minute.
The Commission notes that Unitel used cost data for MCI and Sprint U.S. that was limited to that provided in Annual Reports or filed with the Securities and Exchange Commission, whereas Sprint Canada based its cost data on 1994 internal estimates developed by Sprint U.S. for internal management purposes. Furthermore, the data submitted for toll minutes relied on broad estimates. In final argument, Unitel and Sprint Canada confined their comparisons of Canadian Phase III toll cost per minute to the AT&T-C toll cost per minute.
The Commission also notes that Sprint Canada's cost estimate provided in final argument was based solely on an operating cost per minute that excluded, among other things, switching and aggregation (S&A) and depreciation expense, and represents less than 50% of Bell's Phase III toll costs. Furthermore, Sprint Canada performed limited analysis and, where it was practical to do so, it adopted various Stentor and Unitel costs estimates per minute for cost components in order to develop its cost per minute comparisons of AT&T-C and Bell toll costs. The Commission considers that the evidence submitted by Sprint Canada generally did not provide any further data to augment the data filed by the other parties.
Accordingly, the Commission has based its analysis of the benchmarking results on the submissions made by Unitel and Stentor comparing AT&T-C's toll costs with Bell's Phase III toll costs.
The following tables summarize the submissions of Unitel and Stentor with respect to AT&T-C and Bell (all figures are for the year 1993 and are shown in Canadian cents per minutes (cts/min)):
Filed January 1995 Filed May 1995
Filed January 1995 Filed March 1995
A reconciliation of Unitel's estimates of AT&T-C and Bell costs to Stentor's estimates (submitted by the parties in final argument) are illustrated in the tables found in Attachment A to this Decision.
3. Specific Issues
Parties recognized that Canadian and U.S. costs are not directly comparable. Consequently, various approaches were employed by the parties to attempt to align these costs to permit a meaningful comparison. As a result of the various approaches taken by the parties, specific issues arose during the proceeding as to:
(1) the treatment of Common costs,
These issues are discussed in the sections that follow.
b. Common Costs
Phase III methodology treats Common costs as a separate cost category. On the other hand, AT&T-C toll costs include some Common costs. In order to make Phase III costs comparable to AT&T-C's costs, Unitel added 1.7 cents per minute for Common costs to the Phase III toll cost per minute.
The Commission agrees with Sprint Canada, CAC and Stentor that for benchmarking purposes it is preferable not to allocate Common costs to a particular service segment. The Commission concurs with this approach, since Phase III Common costs, by definition, are not causal to any one category and could only be allocated between local and toll on a judgmental basis.
By contrast, virtually all AT&T-C's "common" costs are attributable to toll since AT&T-C does not provide local service. Accordingly, less judgment is required to exclude the majority of Common costs from AT&T-C's toll costs.
Therefore, the Commission has excluded these Common costs estimates in the benchmarking exercise and has removed 0.8 cents per minute from Unitel's estimate of AT&T-C's toll costs in order to make this estimate comparable to Bell's Phase III toll costs.
c. AT&T-C Minute Variance
Stentor's estimate of AT&T-C minutes, used in the denominator of the cost per minute calculation, was 7.3 billion minutes higher than Unitel's estimate, with Software Defined Network (SDN) minutes accounting for 6.3 billion of the difference. SDN is a virtual private network that utilizes software which routes the customer's traffic (over public switched networks) as if the customer had a dedicated private line.
The Commission notes the SDN is highly competitive and, as a result, there is no publicly available data for this segment of the market. In this regard, Unitel's witness from AT&T-C indicated that the estimate of SDN traffic included in Unitel's AT&T-C cost data (3.3 billion minutes) was within 1% of the actual minutes.
Stentor argued that, based on Unitel's estimate of toll minutes, AT&T-C's average revenue per minute is very high, and that dial equipment minutes are significantly higher than Unitel's AT&T-C estimate of 165 billion minutes, excluding SDN minutes.
The Commission observes that the total minute variation between Unitel and Stentor accounts for a difference of approximately 0.4 cents per minute in their respective cost estimates. All other things being equal, the Commission considers that a variation of this magnitude is not significant in this benchmarking exercise. However, the Commission has performed the benchmarking analysis based on both Stentor's and Unitel's estimates of AT&T-C's toll minutes.
d. Switching and Aggregation Costs
The treatment of Canadian and American switching and aggregation costs proved to be one of the more difficult issues in the benchmarking exercise, due to a lack of discrete information and differences between Canada and the U.S. with regard to the recovery of these costs.
In the U.S., toll services are provided by both Local Exchange Carriers (LECs) and Interexchange Carriers (American IXCs). Through access charges, the American IXCs pay the LECs for the use of their S&A facilities to route a toll call to its final destination.
In the U.S., the S&A function may involve (1) interconnection through a LEC's access tandem switch that is used to interconnect end offices, or (2) direct connection to a local switch (end office). AT&T-C uses the latter arrangement for approximately 90% of its traffic. This arrangement excludes the LECs' access tandem costs and requires the use of a lesser amount of the LECs' trunking facilities. Accordingly, the Commission considers that AT&T-C's S&A costs would generally be lower than those of other American IXCs who use a higher proportion of access tandem and toll connecting facilities.
In Canada, the telephone companies employ a direct connection at the local switch, and costs related to the trunking facilities and any portions of the access tandem switch used for connection of toll traffic are included in the Phase III toll costs.
There are some 1,300 LECs in the U.S., and access charges vary among them (depending on the LEC's cost and the mix of direct and access tandem connections), a factor which complicates efforts to ascertain the underlying U.S. S&A costs. Sprint Canada submitted that these access charges which include S&A charges are designed to meet a variety of cost recovery and revenue requirement objectives, and that some 60% of the charge relates to various subsidies. According to Sprint Canada, if these subsidies were excluded, the cost of access would be approximately 3.8 cents per minute.
Unitel assumed that S&A costs were not part of toll costs for benchmarking purposes, whereas Stentor assumed that they were. Unitel estimated these costs for AT&T-C and Bell to be 3.0 and 3.8 cents per minute (including Common costs), respectively. Stentor estimated AT&T-C's S&A costs to be 2.0 cents per minute, based on the results of three U.S. studies.
Bearing in mind the difficulties inherent in determining AT&T-C S&A costs, the Commission accepts that these costs range from 2.0 to 3.0 cents per minute. The cost of S&A is dependent on, among other things, the type of access connection, the degree to which trunking facilities are required, and the treatment of Common costs.
The Commission notes that, by using the Canadian Phase III Competitive Toll (CT) costs, there is no requirement to isolate these costs as the S&A costs are already assigned to the Phase III toll costs. The Commission further notes that, prior to the implementation of the split rate base, S&A costs were not only part of Phase III toll costs, but also had to be recovered through toll rates and would thus form part of any imputation test. These costs are integral to the toll cost per minute. Accordingly, the Commission concludes that S&A costs should be included in the benchmarking results. Therefore, the Commission has added 2.0 to 3.0 cents per minute to Unitel's estimate of AT&T-C's toll costs.
e. Overseas Costs
Unitel estimated AT&T-C's overseas costs at 0.4 cents per minute, and reduced its estimated costs per minute for AT&T-C accordingly. Stentor maintained that there was insufficient publicly available data to estimate the AT&T-C overseas costs. The Commission notes that the Unitel adjustment is based on limited data and relies mainly on results derived from proration methods yielding broad estimates.
Stentor used an approach that determined Bell's overseas costs to be 1.9 cents per minute based on its proportionate share of traffic and associated costs of Teleglobe Canada Inc. (Teleglobe). This estimate was based on Teleglobe's public financial statements. Stentor submitted that it would be preferable to adjust the AT&T-C costs to compare Canadian domestic toll costs with U.S. domestic toll costs but, in its view, the use of Teleglobe costs produced a more reasonable estimate.
The Commission notes that Stentor and Unitel made attempts to determine a level of overseas costs and each party has put forward various arguments in support of the relative merits of its approach. Nevertheless, based on the evidence submitted and the wide variations in the Canadian and U.S. estimates, the Commission is unable to conclude that the submissions are representative of either the Canadian or U.S. overseas segment.
The Commission further notes that all parties submitted that the preferred approach would be to remove overseas costs from the estimate of AT&T-C toll costs per minute. The Commission agrees with this assessment and considers that it would not be appropriate to join the costs of two companies (i.e., Teleglobe and Bell) for benchmarking purposes.
Accordingly, taking into account the inherent problems noted above, the Commission considers that, in order to compare the costs per minute on a uniform basis, it is necessary to exclude the 1.9 cents per minute of overseas costs from Stentor's estimate of Bell's Phase III toll costs.
f. Financial Expense and Miscellaneous Minor Variances
In addition to the differences noted above, there were other variances in the level of costs incorporated into the benchmarking estimates put forward by the parties.
(i) Financial Expense
Unitel excluded financial expense from its benchmarking results submitted in final argument whereas Stentor included these costs.
In 1993, financial expense reported for Bell's Phase III toll costs amounted to 2.4 cents per minute. The corresponding AT&T-C toll costs per minute were calculated to be approximately 1.3 cents per minute reflecting Stentor's adjustment to align the AT&T-C rate of return on investment to be equivalent to that of Bell. The Commission notes that although Unitel excluded financial expense, Unitel indicated that the Stentor calculation was reasonable. For the purposes of costs per minute reconciliation between AT&T-C and Phase III costs, the Commission has included financial expense to derive total Canadian and U.S. toll costs.
(ii) Miscellaneous Minor Variances
AT&T-C expenses software costs whereas these costs are capitalized in Bell's Phase III toll costs. Unitel therefore increased Bell's Phase III costs by 0.1 cents per minute to achieve consistency with the AT&T-C treatment.
Unitel estimated the AT&T-C adjustment required to remove the impact of an accounting change relating to post-retirement benefits to be 1.0 cents per minute compared to Stentor's adjustment of 0.9 cents per minute.
Unitel and Stentor removed AT&T-C costs related to Private Line and other miscellaneous services based on different approaches. Unitel estimated the adjustment to be 1.9 cents per minute including Common costs compared to Stentor's estimate of 1.4 cents per minute. The Commission considers the variance to be approximately 0.3 cents per minute when Common costs and minute differences are taken into consideration.
g. Summary of Cost Comparisons
As previously noted, by Order-in-Council 1994-2036, the Commission was directed to compare Phase III cost allocations with external benchmarks. Thus, the purpose of this benchmarking exercise is to compare Bell Phase III toll costs with the external benchmark of AT&T-C toll costs. Bell's 1993 Phase III toll costs are 11.3 cents per minute. For reasons noted in Section A.3(e) above, the Commission has rejected Stentor's proposal to include overseas costs of 1.9 cents per minute in this estimate. Unitel's estimate of AT&T-C toll costs is 9.9 cents per minute. In order to make a meaningful comparison of the cost per minute results, the Commission has adjusted Unitel's estimate as discussed previously and as outlined in the following table:
Unitel's Estimate of AT&T-C costs 9.9 Section A.2
Bell Phase III CT costs 11.3
From the figures in the table above, the Commission notes that the 2.1 cents difference is reduced to 0.7 cents per minute when the assumptions are changed (1) to incorporate Stentor's estimate of total AT&T-C toll minutes in lieu of Unitel's estimate (which reduces the AT&T-C toll cost by 0.4 cents per minute), and (2) to substitute Stentor's estimate of 2.0 cents per minute for S&A costs in lieu of the Unitel estimate of 3.0 cents per minute.
Therefore, for the purposes of benchmarking, the Commission finds that the difference between Bell's Phase III toll costs and AT&T-C's toll costs is approximately 1.0 to 2.0 cents per minute.
The Commission considers that the difference of 1.0 to 2.0 cents per minute in cost estimates is minimal at this broad level. The Commission notes that the differences between Canada and the U.S. with respect to operating environments, market conditions and structural factors contribute to the cost per minute differences, but that these differences cannot be identified at this broad aggregate level of benchmarking.
The Commission has considered various operational differences between Canadian and U.S. carriers such as those relating to the U.S. Local Access and Transport Area (LATA) arrangements. Canadian carriers provide intra Number Plan Area toll that is similar to the intraLATA toll services provided in the U.S. by the LECs rather than by AT&T-C or other American IXCs.
The Commission notes that Canadian carriers carry a mix of short and long haul toll traffic whereas the American IXCs carry mostly long haul traffic requiring, on average, longer transmission paths and transit more switches than in Canada. The Commission further notes that the earlier introduction of equal access and 800 number portability in the U.S. results in incremental costs for AT&T-C for which there are no corresponding costs in the 1993 Canadian Phase III costs used in the benchmarking exercise. In light of the above, the Commission is of the view that Canadian toll costs would be lower based on differences in the U.S. and Canadian network configurations.
The Commission also notes that, for U.S. private line and data services, cost data and the associated costing methodology are not publicly available as they are in Canada. This severely limits the Commission's ability to address the reasons for cost differences by detailed activities such as Network, Information and Customer Services.
The Commission notes that, in 1993, LECs performed billing and collection services on behalf of AT&T-C, and that amounts charged to AT&T-C contained mark-ups; by contrast, similar services performed by Bell Sygma on behalf of Bell excluded mark-ups. In addition, the record indicates that AT&T-C was developing its own billing and collection services in 1993, and therefore incurred development costs for these activities. This evidence suggests that, all other things being equal, costs for billing-related activities in 1993 would have been higher for AT&T-C than for Bell.
The Commission has reviewed evidence of other operational differences, such as variations in accounting conventions, composite depreciation rate differences and the potential for variations in research and development programs, which cannot be quantified. Finally, the Commission notes that the costs reported for the regulated activities of AT&T-C are the result of a cost allocation process under the Federal Communications Commission's Part 64 Cost Separation Rules. Differences between the U.S. Cost Separation Rules and the Phase III costing methodology were not addressed by parties in a comprehensive manner.
The Commission notes that parties acknowledged that various operational differences exist. Further, the Commission notes that these differences can only be expressed in a qualitative manner given the structural and regulatory differences and the lack of publicly available information in view of the competitive nature of the business. Based on the evidence, the Commission is satisfied that the 1.0 to 2.0 cents per minute difference can be explained by these operational differences.
Therefore, in light of the above, the Commission concludes that the benchmarking analysis provides evidence to support that existing Phase III assignment methods result in a reasonable allocation of costs between the Utility and Competitive segments. Accordingly, the Commission notes there is no requirement for any reduction in contribution rates based on benchmarking results.
The Commission has found that some changes in Phase III assignment procedures are required for the assignment of joint-use activities, such as billing and collection. These are addressed in Part VII of this Decision. The Commission notes that these adjustments will have only a minor impact on toll costs.
B. Productivity and Local Cost Comparisons
The Commission has reviewed the evidence that compared both local and toll productivity growth and selected local cost comparisons in Canada and the U.S.
With respect to the productivity comparisons, Unitel argued that Bell used revenue-weighted instead of cost-weighted Total Factor Productivity data, and noted the Commission's ruling in Competition in the Provision of Public Long Distance Voice Telephone Services and Related Resale and Sharing Issues, Telecom Decision CRTC 92-12, 12 June 1992 (Decision 92-12), that productivity growth was more accurately estimated using cost weights to aggregate outputs.
The Commission considers that it is more appropriate to compare Bell's calculation, which uses revenue-weighted data, with the revenue-weighted data provided by Unitel for the U.S. carriers.
The Commission is not persuaded that Unitel's evidence demonstrates that there are significant local and long distance productivity imbalances between Bell and U.S. carriers. Accordingly, the Commission considers that this evidence does not support the view that Phase III allocations are unreasonable.
With respect to AGT's local cost comparison study and the concerns expressed by interested parties, the Commission concludes that the study results represent a reasonable comparison of AGT's loop costs with equivalent U.S. costs, and that the evidence supports the identification of access line density per square kilometer as the key explanation for the higher AGT loop costs. The Commission finds that AGT's study provides a useful check on the reasonableness of the company's Phase III Access category and that the results support the view that the existing Phase III assignment procedures are reasonable.
III LOCAL EXCHANGE COST OPTIMIZATION MODEL
FNACQ/NAPO provided an estimate of the incremental cost of local telephone service by using the Local Exchange Cost Optimization Model (LECOM). The LECOM was developed in the U.S. for the National Regulatory Research Institute with the objective of providing American state regulators with an alternative to telephone company cost estimates.
The LECOM estimates minimum costs of providing local telephone service in selected local exchanges. Within those exchanges, the model estimates the total cost of providing telephone service, the total service long run incremental cost of the separate services, and the stand alone cost of supplying each service.
The Commission is of the view that economic cost models can have useful applications in the regulation of the telecommunications industry. The Commission, however, has serious reservations and concerns with respect to the usefulness of the results of this particular model.
The LECOM results were derived on the basis of certain costs and in-service quantities supplied by Bell for three of the company's exchanges. While FNACQ/NAPO testified that the model's cost estimates had been compared to cost estimates for American local exchange companies, the Commission notes that the LECOM cost estimates used in this proceeding were not calibrated to Canadian telephone company costs.
The Commission notes that economies of scope estimated with the LECOM are due, in part, to economies of scale assumed by the model. Specifically, the LECOM uses actual in-service quantities of local, toll, and private line services when estimating the stand alone costs of the different services. The Commission considers that this methodology ignores possible cost reductions from economies of scale and scope that could arise when services are supplied on an integrated basis, and therefore tends to increase the estimated stand alone cost of access to toll and private line services. By contrast, since the majority of calls are local, LECOM assigns most of the cost reductions from economies of scale and scope to local exchange service. In the Commission's view, all services contribute to a telephone company's scale of operations, and all services should benefit from possibly lower costs due to economies of scale and scope.
In the Commission's view, the LECOM does not correctly estimate the stand alone costs of the different services, since a network designed to provide services on a stand alone basis would differ from a network providing all services on an integrated basis. Further, given the degree of integration inherent in modern communication and information networks, it is impractical to supply services on a stand alone basis, and therefore, the Commission sees little relevance for this proceeding in stand alone cost estimates.
In light of the above, the Commission finds the LECOM results to be of no assistance in addressing the issues of this proceeding.
IV RATE REBALANCING
As noted earlier, the Commission stated in Decision 94-19 that the benefits of a more efficient regulatory framework based on price regulation could not be fully realized without bringing rates substantially closer to costs. The Commission concluded that the subsidy provided from long distance to local and access services was substantially larger than necessary to maintain affordable access to telecommunications and imposed an inequitable and unnecessary burden on many long distance users. The Commission also stated that rebalancing could foster the establishment of conditions necessary to ensure the competitiveness of Canadian telecommunications.
Consistent with the above view, in Decision 94-19, the Commission directed the telephone companies to undertake a program of rate rebalancing consisting of annual increases of $2 per month in rates for local service, with corresponding decreases in rates for basic toll service, in each of the years 1995, 1996 and 1997. This process would have been accompanied by reductions in the contribution charge paid by the telephone companies and competitors.
As noted earlier, in Order-in-Council 1994-2036, the Governor in Council referred back to the Commission for reconsideration that portion of Decision 94-19 pursuant to which the Stentor members subject to the Decision were to file tariff revisions providing for local rate increases and offsetting basic toll rate decreases.
In this proceeding, the Stentor companies supported the principles enunciated in Decision 94-19 regarding rate rebalancing. In their view, the Commission's decision to open up the local market to competition made it even more crucial that a rational and efficient pricing structure be put in place. Consistent with this view, the Stentor companies filed company specific proposals entailing three annual increases in the monthly charge for basic local service ranging in each year from $2 to $4 for residential customers and $0 to $4 for business customers.
The Stentor companies indicated that, in addition to these proposals, some of the companies may file separate proposals to restructure local service rates or seek local service rate increases as part of revenue requirement applications. They proposed that the Commission not mandate reductions in rates for toll services, but rather allow market forces to determine the nature, timing and extent of those reductions. The Stentor companies stated that they were seeking to reduce contribution rates to more sustainable levels of 1.0 to 2.0 cents per minute. In addition, the Stentor companies hoped to reduce the gap in the rates among member companies to no more than 1.0 cent per minute in order to pursue national toll service pricing strategies.
CPI; the Director of Investigation and Research, Bureau of Competition Policy; fONOROLA; Sprint Canada; Unitel and several business groups supported rate rebalancing, involving some amount of local rate increase to the extent that it is supported by the costing evidence filed in this proceeding. Some of these parties stated that local rates should be moved towards economic costs but not towards embedded costs. However, these parties agreed that the level of rate rebalancing contemplated by the Commission in Decision 94-19 would not increase local rates above economic costs. Some of these parties indicated that the Commission should mandate reductions to the telephone companies' basic toll service rates.
Consumer group representatives, with the exception of CPI, opposed any rate rebalancing. They based their position on costing evidence (including results from the LECOM) that, in their view, demonstrates that current rates for local service are not below costs, and that therefore, there is no need for rate rebalancing. They submitted that any decision to proceed with rate rebalancing should be postponed until after changes are made to costing methods or assignments or until revenue requirement applications are dealt with. Moreover, they proposed that, should the Commission decide to proceed with rate rebalancing, a proceeding should first be conducted to look at the issue of targeted subsidy programs. These parties also called upon the Commission to mandate reductions to the telephone companies' basic toll service rates.
The Commission notes that both Unitel and Sprint Canada expressed support for a limited schedule of rate rebalancing, allowing local rates to increase in 1996 and 1997, offset by equivalent reductions in the CAT. In Unitel's submission, local rates should specifically be increased by $2 per month per year, accompanied by mandated reductions in basic toll service rates.
In the opinion of the Commission, the record of this proceeding confirms the findings in Decision 94-19 with respect to the need for and the benefits of rate rebalancing. In this regard, the Commission notes its finding elsewhere in this Decision that the results of the benchmarking analysis provide evidence to support that existing Phase III assignment methods result in a reasonable allocation of costs between the Utility and Competitive segments. Furthermore, based on other evidence filed in this proceeding respecting adjustments to Phase III, the treatment of economies of scope and the split rate base methodology, the Commission concludes that, absent some form of rate rebalancing, the Utility segment shortfall will remain substantially above the level necessary to achieve the regulatory reforms set out in Decision 94-19.
The Commission considers that the evidence in this proceeding supports previous findings that local services are priced, on average, below cost. In the Commission's view, rate rebalancing, as established in this Decision, will lessen the substantial subsidy that flows to local and access services from long distance services (via the CAT which is paid by all long distance service providers) in a manner consistent with the objectives of the Act to maintain affordable access to telecommunications services. Furthermore, the Commission confirms its finding in Decision 94-19 that, while productivity improvements and revenues from new optional services will help to reduce the Utility segment shortfall, these factors alone are not sufficient to bring the subsidy down to an appropriate level.
Some parties raised concerns that the benefits of rate rebalancing will not be evenly distributed, noting that under the current system, subscribers who are low-volume toll users are less likely to benefit from rate rebalancing than heavy toll users. In Decision 94-19, the Commission recognized that low-volume toll users who are less likely to benefit from rebalancing may also be low-income users. This finding is further supported by information filed in this proceeding by FNACQ/NAPO. The Commission considers that equity between heavy and low-volume toll users is best achieved if toll rate reductions, under rate rebalancing, are directed at the basic toll services which tend to be used by low-volume residential and business customers. In the Commission's view, if the general body of subscribers is to pay higher proportionate local rates to establish a more efficient, equitable and sustainable system, the public interest is best served by having the benefits of lower long distance prices also flow to the general body of subscribers. The Commission notes that, unlike large volume toll services, the rates for basic toll services have not declined significantly since Decision 92-12.
In light of the above considerations, the Commission finds it appropriate that the telephone companies proceed with a rate rebalancing plan. As in Decision 94-19, the contribution component of the CAT should be reduced by an amount equivalent to the revenues derived from the local rate increases contained in the rebalancing plan, with long distance revenues being reduced by an amount equivalent to the reduced CAT expenses charged to the telephone companies' Competitive segments.
The Commission further considers that it is reasonable to limit the impact of local rate increases associated with rate rebalancing to annual increases of $2 per month, to be implemented over the next two years, with the third rebalancing component to be implemented with the introduction of price cap regulation. The magnitude of the third component will be considered in the proceeding to implement price caps.
The Commission notes that some companies' cost data would suggest that increases greater than $2 per month would be required to reduce their shortfall to the same proportionate levels as other companies; however, the Commission considers that the goal of economic efficiency must be tempered by consideration of the potential impact on subscribers. The Commission is of the view that limiting the annual local increases associated with rate rebalancing to a fixed dollar amount is necessary in order to lessen the total bill impact on low-volume toll users. Moreover, the phased design of the rate rebalancing program will further control the impact on subscribers.
If a company can demonstrate to the Commission that rates for business customers for a particular local service in a particular rate group are already compensatory, the company may propose not to increase the associated rates.
The Stentor companies (other than MT&T) are directed to file, in the form of tariff applications, rate rebalancing proposals (local rate increases and long distance rate reductions) that are consistent with the above, to take effect 1 January of each of the years 1996 and 1997. These proposals are to be filed no later than 1 December 1995 and 1 December 1996, respectively.
The Commission notes that in Maritime Tel & Tel Limited - Application for Interim Rate Increases and Tariff Notice 501, Telecom Decision CRTC 95-7, 1 May 1995 (Decision 95-7), MT&T was granted an interim increase in residential local rates of $2.10 per month effective 1 May 1995. In Decision 95-7, the Commission concluded that any proceeding to deal with final rates for 1995 should be delayed until after the issuance of its decision in this proceeding. Accordingly, the Commission directed the company to file revised forecasts for 1995 and 1996 within 30 days of the issuance of the present Decision, stating that the Commission would establish, at that time, the nature and scope of the final review of MT&T's Utility segment rates.
The Commission is of the view that, should this final review result in local rate levels near to those approved on an interim basis, MT&T's subscribers would experience a larger increase than they should reasonably be expected to bear if, in addition, a further increase of $2 per month were to occur effective 1 January 1996 as a result of rate rebalancing. Accordingly, should MT&T be granted final rates similar to those approved on an interim basis, the Commission will direct MT&T to file rate rebalancing proposals, entailing local rate increases of $2 per month to take effect 1 May for each of the years 1996 and 1997. MT&T is to file its proposals no later than 1 April in each of these years, under the same terms as set out in this Decision for the other Stentor companies.
Should the final review of MT&T's 1995 Utility segment rates result in local rates that are significantly lower than those granted interim approval, the Commission will issue further directions as to how the company should proceed with the filing of rate rebalancing proposals.
The long distance rate reductions to be filed by all Stentor companies are to consist of reductions in their basic toll schedules for North American rates sufficient to result in an after-settlement revenue reduction (assuming no stimulation in demand due to the basic toll rate reductions) equivalent to the reduction in contribution charged to the Competitive segment arising from the local rate increases. The Commission notes that reductions to the basic toll schedule will result in reductions in the effective rates charged for other services that rely on the basic toll schedules (e.g., Real Plus), the impact of which is to be included in considering the overall rate reductions.
The Commission would expect to give expeditious approval to the rate rebalancing proposals, provided they satisfy the criteria established in Decision 94-19 for expedited approval of toll rates, i.e., that the revisions meet the imputation test and do not result in an increase in overall off-peak rates.
The Commission considers it appropriate that contribution charges be reduced coincident with the local rate increases to reflect the rate rebalancing initiative. Accordingly, with the exception of Newfoundland Tel, the telephone companies are directed to file with their annual rate rebalancing proposals a new proposed CAT, reflecting a reduced contribution charge. The calculation of the charge is to be conducted in the same manner as described at page 131 of Decision 94-19. The Commission notes that, as discussed in Part VIII of this Decision, Newfoundland Tel is not required to file reductions in its contribution charge in 1996 or 1997, although the company is required to file local rate increases of $2 in 1996 and 1997 with toll rate reductions which offset the local rate increases.
Most of the consumer groups participating in this proceeding submitted that, if rate rebalancing proceeded, some form of targeted subsidy program would be necessary. Having considered the evidence, the Commission remains of the view expressed in Decision 94-19 that such a program is not required at this time, in light of the form and degree of rebalancing mandated in this Decision.
While the Commission does not consider a lifeline program necessary at this time, it notes that AGT indicated its intention to file proposals for optional local service packages designed to address concerns with respect to local service affordability for low-income subscribers. The Commission considers that any such proposal should be considered in a broad public process in which interested parties are given the opportunity to discuss the implications of implementing such a plan.
V PRICE CAPS
In Decision 94-19, the Commission considered that a move to price cap regulation, rather than earnings regulation, is consistent with its objective of placing greater reliance on market forces and would be more appropriate for regulating Utility segment services in an increasingly competitive environment. However, it was recognized that price cap regulation would not produce anticipated benefits, such as reduced regulation and increased incentives to reduce costs, until rates are closer to costs.
In this proceeding, several parties indicated that the implementation of price caps could be accelerated to 1 January 1997. CCTA and Unitel proposed that it be advanced even further to 1 July 1996. These parties submitted that the earlier introduction of price caps would reduce the incentives for the telephone companies to over-invest in the Utility segment and to misallocate costs. In this context, particular concern was raised with respect to the telephone companies' plans to invest in the Beacon Initiative (discussed below). Parties were generally of the view that the Commission's stated plan for rate rebalancing, as set out in Decision 94-19, could be incorporated into a price cap regime.
In Stentor's view, accelerating the introduction of price caps to 1 January 1997 would require that certain conditions be satisfied. These would include (1) having Utility segment rates set to allow the Utility segment a reasonable opportunity to earn a fair rate of return at the start of the price cap regime, and (2) establishing a program of rate rebalancing and local rate restructuring to be reflected in the price caps with, preferably, a substantial measure of rate rebalancing completed prior to the implementation of price caps.
The Commission outlined the benefits of price caps in Decision 94-19. It stated that price caps allow for more efficient and effective regulation in a number of ways. First, price caps reduce incentives and opportunities for companies to over-invest or misallocate costs. Once caps are established, prices cannot exceed them (unless through the operation of a limited number of exogenous variables) even if the investment base is increased. Second, price caps reduce opportunities to cross-subsidize or engage in anti-competitive pricing, because price changes in one basket of services cannot be offset by changes in others. Third, price caps provide incentives for telephone companies to be more efficient and innovative, since shareholders assume more of the risks and receive the rewards of business decisions and retain the benefits of higher levels of productivity. Fourth, price caps can eliminate the need for regulatory assessment of investment, expenses and earnings between price cap performance reviews.
The Commission considers that the telephone companies' plans to implement the Beacon Initiative have raised several concerns that could be mitigated by accelerating the move to price caps. Generally, these concerns are that the Utility segment rate base may be inflated prior to the implementation of price caps, that Utility segment subscribers may bear some of the risk of this investment or that the telephone companies may cross-subsidize the costs of the Beacon Initiative from Utility segment subscribers. However, the Commission considers that, as discussed in Part VI below, these concerns can be appropriately addressed through other mechanisms.
The Commission is also of the view that the benefits of an earlier introduction of price caps must be weighed against the disadvantages that acceleration would create. In particular, the Commission recognized in Decision 94-19 that a transition period was necessary prior to price caps in order to allow for rates to be moved closer to costs. If such a transition period is not provided for, due to accelerating the move to price caps, the current cost/revenue imbalances will have to be incorporated into the cap and some means developed to reduce the imbalance without the need to resort to the present method of calculating contribution charges. Absent this, price caps would not produce the anticipated benefits, such as reduced regulation and increased incentives to reduce costs. Until the contribution rate has been reduced to a level that represents a less significant expense and is closer to a minimal mark-up on access, many elements of earnings regulation will have to be retained in the price cap regime; otherwise, the full benefits of regulatory streamlining and other benefits of price regulation will not be realized.
Finally, the Commission notes that the delay in implementing rate rebalancing until 1 January 1996 also delays the process for addressing the current cost/revenue imbalances. While this may suggest delaying the implementation of price caps beyond 1 January 1998, the Commission is of the view that such a delay is not warranted given the importance of moving to price cap regulation in an environment of increasing broadband investment and local competition.
In light of the above, the Commission is of the view that it is appropriate to provide for some transitional period in order to minimize the extent to which elements of earnings regulation are carried over into price caps and to properly deal with the issues noted above. Accordingly, the Commission will be initiating a proceeding in early 1996 with a view to implementing price cap regulation effective 1 January 1998.
In Decision 94-19, the Commission stated that it would be necessary to monitor investment by the telephone companies carefully as they prepare to invest considerable amounts in broadband infrastructure. The Commission considered such monitoring necessary in order to ensure that the Utility segment rate base is not inflated prior to moving to price caps and to control the impact of investment on basic local rates during the transitional period.
As noted in Public Notice 94-52, the Stentor companies are planning to make a substantial investment in broadband infrastructure, and the Commission must be satisfied that any capital investment in broadband facilities that forms part of the Utility segment is justified and recovered in an appropriate manner. In this regard, in Public Notice 94-52, the Commission sought submissions respecting, among other things, (1) the appropriate allocation of broadband investment between the Utility and Competitive segments, (2) mechanisms to ensure that the telephone companies do not cross-subsidize the investment, inflate the Utility segment rate base or cause any inappropriate increase in Utility segment rates or expenses during the transitional period, and (3) the impact of such investment on contribution and Utility segment rates.
B. Stentor's Proposed Treatment
In its evidence, Stentor proposed to assign all Beacon Initiative investments and related operating expenses, as well as those associated with new non-Beacon broadband access services, to the Competitive segment. Stentor defined the Beacon platform as including the feeder cable, opto-electrical nodes, distribution cables, customer drop and customer interface equipment (wall box) at the subscriber's premise, all of which are necessary to establish broadband access to primarily residential customers. Stentor indicated that the Beacon platform, as viewed currently, uses a hybrid fibre-coaxial architecture, although it may include asymmetrical digital subscriber line technology and may evolve to include fibre to the curb or the home.
Stentor submitted that its proposals with respect to the regulatory treatment of Beacon and new broadband initiatives provide a number of safeguards to protect Utility segment subscribers from the impact of the new broadband investment. Under Stentor's proposed treatment, the Beacon investment is assigned to the Competitive segment and any investment associated with existing broadband access services or any modification that does not "introduce substantially new communications functionality" would be assigned to the Utility segment.
Stentor proposed additional safeguards relating to the valuation of fibre transferred between the Competitive and Utility segments, the treatment of spare capacity, the setting of transfer prices and the establishment of tracking mechanisms. Stentor argued that its proposed safeguards would ensure that any risk associated with the Beacon Initiative would be borne entirely by the shareholders and that Utility segment subscribers would be isolated from bearing any of the associated risks or costs.
In particular, Stentor proposed that, when Beacon services require the use of existing Utility segment resources such as fibre, those resources be re-assigned to the Competitive segment at gross book value. In Stentor's view, this would ensure that Utility segment subscribers do not bear the depreciation expense associated with spare capacity fibre transferred to the Competitive segment. Stentor also proposed to assign spare access fibre capacity based on forecasted use, rather than on current use. Stentor stated that this would ensure that the amount of spare access capacity assigned to the Competitive segment takes into account the expectation that broadband investment for Beacon services will grow faster than broadband investment assigned to the Utility segment, and would avoid the problem of relying on current usage levels, which would skew the allocation towards the Utility segment. It was further suggested that forecasts of fibre use by the Utility segment be subject to regulatory review during rate cases or when price caps are implemented.
Stentor indicated that it does not expect that basic local services will be provided over Beacon facilities until at least 1997. However, in the event that such services were to share fibre facilities assigned to the Competitive segment, Stentor proposed to establish a transfer price to be charged to the Utility segment.
Stentor proposed that the transfer price be set within a zone of reasonableness. Stentor considered that there would be no issue of cross-subsidy associated with any price within the zone, and therefore the Commission need only be concerned with the end points of the zone. The upper end would be equal to the opportunity cost, as determined by the lowest cost that would be incurred to construct facilities necessary to provide equivalent Utility segment service using the least cost technology available. The lower end would be equal to a price determined by the interaction of supply and demand in a competitive marketplace for delivery of the same service. Stentor expected that it would take some time to develop more fully the actual level and range of transfer prices.
Stentor also proposed to assign all costs associated with support structures unique to Beacon access infrastructure to the Competitive segment. Where Beacon overlay facilities require the use of existing support structures assigned to the Utility segment, Stentor proposed to have the Competitive segment pay the Utility segment the market rate, as approved by the Commission pursuant to Access to Telephone Company Support Structures, Telecom Decision CRTC 95-13, 22 June 1995.
Stentor stated that a Video Access Tariff (VAT) would be available to third-party service providers to enable them to provide services to Beacon subscribers. Stentor proposed that the VAT be market-based and that the revenues from it be assigned to the Competitive segment.
Stentor submitted that, where direct assignment is possible, existing tracking mechanisms could be used to ensure that new broadband investment and related expenses are properly assigned. Where direct assignment is not possible, Stentor indicated that Phase III costing studies would be undertaken and the Phase III Manuals updated accordingly. Stentor also submitted that unique field codes had been, or would be, established for all components of the Beacon infrastructure. According to Stentor, the current annual Construction Program Review (CPR) provides an opportunity for public scrutiny of the companies' cost assignments. In addition, Stentor proposed to report on inter-segment transfers related to Beacon, including any transfers of Utility segment fibre facilities to the Competitive segment and vice-versa, and any transfer payments or tariffs paid from the Utility segment to the Competitive segment or vice-versa.
In considering the regulatory treatment to be applied to the Stentor companies' broadband initiatives, the Commission has been guided by the policy objectives set out in the Act and its conclusions in previous decisions, as well as the concerns raised by parties in this proceeding. The Commission considers it essential that the regulatory treatment of such a large undertaking be fair to consumers and competitors and ensure that shareholders both assume the risks and receive the rewards of their investment.
The Commission is of the view that Utility segment subscribers must be protected from bearing the risk associated with the telephone companies' new broadband investment. If this is not assured, the Utility segment rate base could be inflated, resulting in upward pressure on local rates. This is of particular concern during the transitional period. Several parties to this proceeding suggested that the best means of providing this assurance would be to assign all existing and future investments for fibre and other broadband-capable facilities to the telephone companies' Competitive segments. In this context, one of the most commonly cited concerns was the potential for the telephone companies to allocate too much spare access fibre capacity to the Utility segment. As noted elsewhere, parties also proposed accelerating the introduction of price caps in order to shorten the transitional period during which such misallocations might occur.
Further, the Commission considers it necessary to ensure that the regulatory treatment of broadband initiatives allows for a fair competitive market, wherein telephone companies are not permitted to engage in predatory pricing or the cross-subsidization of new broadband services by Utility segment subscribers. In addition, competitors must be permitted access to the network on a non-discriminatory basis. In this context, some parties indicated that competition would be enhanced if all fibre was allocated to the Competitive segment and transfer prices to the Utility segment were based on incremental costs. Some parties also submitted that the telephone companies should be required to unbundle the new broadband components of the network and use Phase II costing principles to establish tariffs.
In the opinion of the Commission, the telephone companies should not be restricted in the technology they adopt, as long as any investment attributed to the Utility segment during the transitional period is economically justified and appropriately recovered. In addition, the Commission notes that, in the past, the telephone companies have been permitted to include in their rate bases investments in fibre and related expenses for the provision of Utility segment services. Specifically, the telephone companies have been deploying fibre facilities in the access network, the inter-office trunk network and the inter-city trunk network for several years. Some parties questioned the reasonableness of allowing previously approved fibre investments to remain assigned to the Utility segment, because, in their view, this would present too great a risk that resources assigned to the Utility segment would be used to provide Beacon services.
The Commission finds that, in general, the most appropriate regulatory treatment for broadband initiatives is to require the telephone companies to assign to the Competitive segment all new investments and related expenses associated with the deployment of fibre, coaxial cable, opto-electrical equipment, asynchronous transfer mode (ATM) switches, and video servers. For the purposes of the Decision, these new broadband investments and related expenses are those incurred as of the start of the split rate base regime, i.e., incurred after 31 December 1994.
As an exception to this general rule, the Commission considers that, as found in the past, there are circumstances where fibre is the most efficient and cost effective serving technology for the provision of Utility segment services. In recognition of this, the Commission is prepared to permit investment in new fibre facilities (including associated terminal equipment) to be included in the Utility segment rate base, provided that these facilities are or will become used and useful entirely for the provision of Utility segment services within twelve months of the in-service placement. The Commission considers that used and useful fibre facilities would include fibre strands actively carrying Utility segment services traffic, as well as a reasonable number of strands designated for emergency restoration of service.
The above-noted assignment of fibre to the Utility segment will apply only to feeder cable, host-remote links and the inter-office trunk network facilities used to provide Utility segment services within an exchange. The Commission does not foresee any instances where it would be appropriate to have fibre or coaxial cables in the distribution portion of the loop assigned to the Utility segment. For the purposes of this Decision, fibre feeder cable is defined as the fibre facilities used for communications between a central office, or a remote of a central office, and an opto-electrical device that interfaces with copper facilities in the distribution portion of the loop for the provision of Utility segment services. For the purposes of this Decision, the distribution portion of the loop is defined as the facilities between the opto-electrical device and the demarcation device on the subscriber's premises.
The telephone companies will be required to provide the Commission with sufficient evidence as to the appropriateness of allocating any new fibre to the Utility segment. Procedures to determine the appropriateness of such assignments will be implemented in the tracking procedures to be filed in the CPR and Phase III processes, as discussed below.
The Commission notes that, as a result of the regulatory treatment described above, spare capacity in fibre facilities will be initially assigned to the Competitive segment. However, there may be circumstances where fiber facilities could later be found to be of use for the provision of Utility segment services. If fibre strands and the associated terminal equipment are to be used entirely for Utility segment services, without any sharing by services of the Competitive segment, the Commission considers it reasonable that the related investment be re-assigned to the Utility segment at gross book value. The Commission will require any re-assignments to be justified on the same basis as initial assignments of new fibre investments are made to the Utility segment.
The Commission does not consider that this re-assignment at gross book value should apply in those instances where the telephone companies use new broadband infrastructure to provide, on a shared basis, both basic local telephone service, or other Utility segment services, and Beacon services on the same facility, i.e., to derive logical voice grade channels. In the latter circumstances, the Commission considers transfer pricing, as described below, to be more appropriate.
Specifically, the Commission considers it reasonable for the telephone companies to charge a transfer price to the Utility segment in those circumstances where Utility segment services, such as basic local service and bottleneck services provided to competitors, are provided through shared use of broadband facilities assigned to the Competitive segment. Further, as with other bottleneck services, use of these Utility segment resources by the Competitive segments of the telephone companies or by competitors should be subject to a tariff.
In the Commission's view, because the provision of Utility segment services such as basic local telephony does not require the capability inherent in the broadband infrastructure, the transfer price established for such services should be based on the Phase II incremental costs incurred by the Competitive segment to provide these services, with an appropriate mark-up, recognizing that there will be circumstances where the incremental costs are negligible. Further, the Commission considers that the level at which the transfer price is set should allow for some reasonable portion of the cost savings associated with delivering Utility segment services over the broadband infrastructure to flow to the Utility segment. The telephone companies are directed to file, at least 120 days prior to the proposed effective date, proposed tariffs for the transfer prices.
Through their Beacon initiatives, some telephone companies are deploying broadband capability in their access networks. As noted in its report to the government, Competition and Culture on Canada's Information Highway: Managing the Realities of Transition, 19 May 1995, the Commission considers interconnection among networks to be critical for the development of competition in the provision of new broadband services. The Commission considers Stentor's proposal to provide access to third-party service providers subject to some form of VAT to be consistent with this goal. Accordingly, the Commission directs the telephone companies to develop a VAT for the provision of broadband access to the telephone companies' distribution systems. Subject to priority carriage requirements established under the Broadcasting Act and capacity limitations, the VAT should allow other service providers to have access to broadband loops on a non-discriminatory and unbundled basis, and must be in place at such time as broadband access is available to the telephone companies for the provision of their own broadband services.
The Commission considers it important that the same VAT rate be charged equitably to all providers of broadband services. Therefore, when pricing their own broadband services, the telephone companies are required to impute, as their cost, the rates specified in the VAT. The costing of the VAT is to be based on Phase II incremental costs.
The Commission notes that, as stated elsewhere in this Decision, the telephone companies' existing fibre or other broadband-capable investments and related expenses assigned to the Utility segment on or before 31 December 1994 will remain so assigned. If the telephone companies later decide that any such investments assigned to the Utility segment as of 1 January 1995 become useful for the provision of Beacon or other new broadband services, they must be re-assigned to the Competitive segment at gross book value.
The Commission also concludes that any investment or related expenses, including research and development expenses, whether incurred prior to or after 1 January 1995, for any Beacon or other broadband-related market or technical trials must be allocated to the Competitive segment.
The Commission considers that the regulatory treatment set out above best ensures that Utility segment service subscribers do not bear any of the risk associated with new broadband investment. In particular, it ensures that spare capacity that may only subsequently become useful for the provision of new broadband services is not warehoused in the Utility segment. Further, it addresses the need for a fair treatment of such a large investment for competitors and shareholders of the telephone companies.
D. Tracking Requirements
The Commission finds that, during the transitional period, the telephone companies should be required to identify and track, for each of the Utility and Competitive segments, all capital investment and expenses associated with Beacon and any other new broadband initiatives, i.e., those incurred after 31 December 1994. The Commission also finds that it will remain necessary to identify and to track capital expenditures associated with the ongoing deployment of Fibre Optic Transmission Systems (FOTS) facilities in the access network and the metropolitan inter-office portion of the trunk network, during the transitional period.
The Commission notes that capital expenditures and related deployment data associated with fibre installation have been monitored in the annual CPRs. In recent years, these reviews have been conducted internally by Commission staff, without initiating a formal proceeding. Exceptions to this recent practice have occurred where CPRs have been conducted as part of rate case or revenue requirement proceedings. Under the current practice, the telephone companies' CPR submissions, including all ancillary information, are generally placed on the public record where they may be reviewed and commented on by interested parties. This practice will continue.
The Commission notes that the tracking commitments made by Stentor on behalf of the telephone companies have been an important factor in the Commission's decision to adopt the regulatory treatment set out in this Decision. Accordingly, the Commission has incorporated many of these commitments in the tracking requirements set out below. The Commission is of the view that these commitments should also apply to inter-office trunk facilities and to any other new broadband initiatives.
The telephone companies are directed to include the following detailed information with their annual CPR submissions:
(1) actual and forecast cost data indicating, at an equipment/facility sub-category level of detail, the annual capital expenditures associated with Beacon and any other broadband initiatives (comprising the annual forecasts for two years and actual results for each of the previous two years);
(2) the proposed Utility/Competitive segment assignment of such expenditures, including a report outlining all changes in Utility segment FOTS facilities (i.e., transfers of Utility segment FOTS facilities to the Competitive segment and vice-versa), identifying the associated investments, explaining the related drivers and outlining the economic justification for such investments;
(3) actual-over-forecast expenditure comparisons for expenditures in each of the previous two years, including a detailed explanation of any significant expenditure variances;
(4) actual and forecast cost/demand ratios for Utility segment growth (demand) expenditures (comprising the annual forecasts for three years and actual results for each of the previous two years), with adjustments applied for major trend variations, where possible, and including detailed explanations of major trend variations;
(5) an indication of the actual number of Network Access Services (NAS) (or access lines) which are served by access network broadband facilities that have FOTS facilities in place and the proportion of the total NAS served in this manner; and
(6) reports providing investment data (at gross book value), as of year-end 1994, indicating the actual aggregate costs of FOTS facilities deployed in each of the access network and the metropolitan inter-office portion of the trunk network.
The companies are also directed to continue to provide the FOTS utilization data previously reported in their annual CPR submissions.
The Commission notes that the regular 15 January 1996 Phase III Update filing is issued to a limited number of registered parties. The companies are therefore directed to file the following information as a separate submission, serving copies on parties to this proceeding, by 15 January 1996:
(1) (a) a detailed description of any contemplated changes to Phase III costing studies to reflect the capture and assignment of all new broadband expenditures and expenses, (b) a proposed supplementary schedule to be included with actual and forecast Phase III results, and (c) updated Phase III Manuals with respect to broadband (FOTS) facilities; and
(2) a detailed description of the proposed methodology for tracking and reporting investments, expenses and transfer price payments related to the provision and use of Beacon or other new broadband access facilities, including a description of the separate Beacon or other broadband tracking accounts or field codes for investments and expenses.
Parties may file comments with regard to the above information, serving copies on the companies, by 15 February 1996. The companies' replies are to be filed, and copies served on parties who filed comments, by 1 March 1996.
The companies are also directed to file, coincident with the filings required in the annual Contribution proceeding, forecast information pertaining to inter-segment transfers relating to Beacon and any other broadband initiatives, including transfers or other tariff payments from the Utility segment to the Competitive segment, and vice-versa, for the use of the resources in the other segment.
Once price caps are implemented, the reporting requirements set out above may no longer be necessary. However, the Commission will expect the telephone companies to retain such records as will be required for the purposes of price cap reviews conducted at the end of each price cap term. The level of detail necessary for such reviews will be considered further in the proceeding to establish price caps.
VII SPLIT RATE BASE
A. General Methodology
As noted earlier, in Decision 94-19, the Commission determined that the rate bases of the Stentor companies would be split using Phase III costing as a starting point, based substantially on the methodology proposed by Stentor in the proceeding leading to that Decision. Pursuant to that methodology, the Utility segment would include (1) the Phase III Monopoly Local (ML) and Access categories, as currently defined, (2) a new Utility "Other" category, and (3) a portion of Common costs. Further, the Plant Under Construction (PUC) category would be eliminated, and adjustments would be made to take into account PUC and the Allowance for Funds used during Construction (AFC).
In Decision 94-19, the Commission required each telephone company, in calculating the contribution requirement of its Utility segment, to use the lesser of its forecasted rate of return on average common equity (ROE) and the mid-point ROE (approved in Decision 94-19) of its Utility segment. In addition, the per-minute contribution charge was to be calculated to generate sufficient revenue to allow the Utility segment to earn the above ROE before the contribution discount was applied. If the contribution charge so calculated should exceed that for the previous year, the contribution charge would be maintained at its existing level.
On 31 January 1995, Stentor, on behalf of its member companies, filed its split rate base proposal based on the methodology described above. Issues regarding this methodology are discussed in the remainder of this Section. Other issues regarding the split rate base are discussed in Section B below. Issues specific to particular companies are dealt with in Section C below.
2. Calculation of Contribution Requirement
Stentor's proposed methodology splits Phase III forecast results for the entire company into Utility and Competitive segments, as outlined in Decision 94-19, and the resulting Phase III shortfall for the Utility segment is used as the basis for calculating the contribution requirement. The Stentor methodology incorporates the forecast company-wide ROE (as a cost in the Phase III results) in setting the contribution rate for 1995. For the subsequent years of the transitional period, Stentor proposed to use the Utility segment forecast ROE, since the Utility segment would then have been established.
The Commission requested each telephone company to provide split rate base results for 1995 with the per-minute contribution rate set to achieve the mid-point of the Utility segment ROE range, rather than the forecast company-wide ROE [interrogatory (CRTC)1Nov94-402 (CRTC-402)].
Subsequently, the Commission requested each telephone company to calculate the contribution amount as the difference between the telephone company's Utility segment costs (including a return on equity based on the mid-point of the Utility segment ROE range) and the company's Utility segment revenues (excluding entrants' contribution payments). This amount divided by total minutes (telephone company and entrants) yields the per-minute contribution rate [interrogatory CRTC)7Apr95-2401 (CRTC-2401)].
As between the methodologies in CRTC-402 and CRTC-2401, the CRTC-2401 methodology results in a lower contribution rate because the implicit discounts are not recovered in the contribution rate under this methodology.
Of these two methodologies, Stentor indicated a preference for the CRTC-2401 methodology. However, Stentor took the position that its company-wide ROE methodology should be used to determine the initial contribution rate going into the split rate base regime. Stentor argued that, while the objective is to break the link between local rate increases and toll rate decreases for the future, the new framework should be initialized in harmony with the old. Stentor submitted that the difference in its methodology is limited to the first year of the transitional period (1995). Stentor and AGT both acknowledged the appropriateness of using the CRTC-402 or CRTC-2401 methodology subsequent to that year.
Unitel submitted that the use of a company-wide ROE will not break the link between local and toll rates, arguing that Stentor's proposal represents one last attempt to recover toll rate reductions through local rate increases.
FNACQ/NAPO took the position that the Stentor methodology effectively postpones the severance of the link between local and toll rates, and transfers the burden of losses due to overly aggressive toll reductions to Utility segment ratepayers.
The Commission agrees that adoption of the Stentor methodology for 1995 would result in a lower ROE for the Utility segment, putting upward pressure on local rates.
The Commission considers that a methodology involving the Utility segment ROE, coupled with the determinations in this Decision regarding rate rebalancing, provides a more controlled mechanism for reducing contribution, with the resultant reductions in basic toll schedules benefitting a wider segment of the general subscriber population.
The Commission further considers that the use of the Stentor methodology for 1995 is clearly contrary to one of the objectives of Decision 94-19; to break the link between local and toll rates from the outset of the transitional period. In the Commission's view the adoption of either the CRTC-402 or CRTC-2401 Utility segment ROE methodology would achieve this objective.
As to the choice between the latter two methodologies, the Commission finds the calculation described in CRTC-2401 to be the more appropriate methodology as it is consistent with its determination in Decision 94-19 to calculate the contribution rate on a pre-discount basis.
In light of the above, the Commission directs the Stentor companies to calculate their contribution requirements using the methodology detailed in CRTC-2401 for 1995 and the remainder of the transitional period.
3. Allocation of Common Costs
Stentor and the majority of other interested parties supported the allocation of Common costs to the Utility and Competitive segments based on operating expenses. The Commission agrees with this approach, since operating expenses fairly represent the activities required to operate and administer a business.
Stentor proposed to exclude CAT payments from operating expenses in allocating Common costs between Utility and Competitive segments, on the basis that Common costs are more appropriately associated with costs that are actually incurred. Unitel recommended that such payments be included, arguing that one of the reasons for splitting the rate base and establishing the CAT was to put the Stentor companies' Competitive segments in the same position as competitors in dealing with the Utility segment. As such, Unitel opposed Stentor's proposal to exclude CAT payments from operating expenses in allocating Common costs.
The Commission notes that CAT payments are a cost of doing business for the entrants. Similarly, it is appropriate that the CAT be imputed as an expense to the Stentor companies' Competitive segments. Accordingly, the Commission directs the telephone companies to include CAT payments as operating expenses for the purposes of allocating Common costs between the segments.
4. Plant Under Construction and Allowance for Funds used During Construction
In accordance with Decision 94-19, Stentor proposed to eliminate PUC as a separate category and to assign it to Phase III categories by relating the elements of plant in PUC with the related Phase III investment ratio. Stentor also proposed to assign AFC to the categories based on the assignment of PUC. The Commission considers Stentor's proposed treatment to be reasonable.
5. Economies of Scope and Allocation of Costs of Integrated Facilities and Activities
a. Economies of Scope
A number of parties identified activities associated with the joint provision of Utility and Competitive segment services that they submitted may give rise to significant economies of scope. As sources of economies of scope, ACC et al., Stentor and Unitel identified activities related to network planning, installation, operation, and maintenance; operational processes (business office personnel, operator services personnel, billing and collection functions); marketing/advertising; and general overhead and administration.
Having considered the evidence, the Commission concludes that economies of scope are pervasive in the telecommunications industry arising from many of the same activities and processes noted above by parties.
The Commission notes that, except for FNACQ/NAPO's estimate in the LECOM, none of the parties provided any estimate of the magnitude of economies of scope. Almost all parties agreed that there is no demonstrated need to estimate economies of scope, because such economies can be more accurately and efficiently allocated using less complex and more transparent methods. Further, the Commission notes the evidence presented by Stentor on the inherent problems in estimation methodologies and the difficulty of obtaining objective estimates.
The Commission agrees with parties that it is not necessary to develop or use cost estimation techniques to allocate economies of scope.
The Commission also agrees with the position of some parties that the cost savings arising from economies of scope are intrinsic to (and inseparable from) the companies' cost structure. The Commission also accepts the position of parties that the issue of allocating economies of scope between the Utility and Competitive segments is essentially a question of the appropriate assignment of the costs of jointly-used facilities, irrespective of whether those facilities result in economies of scope. In this regard, three main approaches for the regulatory treatment of economies of scope were put forth: (1) imposing a special charge on the dominant integrated telephone companies, (2) directly assigning costs, unbundling, tariffing bottleneck services and using transfer prices for non-bottleneck services (the ACC et al. proposal), or (3) modifying Phase III.
The Commission notes that, with respect to the implementation of a special charge on the dominant integrated telephone companies, there was little or no evidence provided to support such an approach.
The ACC et al. proposal requires the provision of services by the Competitive segment to the Utility segment, simulating an arm's length transaction. This approach relies on the direct assignment of costs, unbundling tariffs for bottleneck facilities and transfer pricing for non-bottleneck services. It would employ cost allocation only as a last resort, and only for a small number of items that could not be assigned to either the Utility or Competitive segment.
The Commission is not persuaded that the approach proposed by ACC et al. offers, at this time, a significant improvement over the current Phase III approach. Under the current Phase III methodology, costs are allocated using direct assignments at a detailed level wherever possible. The Commission agrees with the criticism raised by Stentor and AGT that immediate and full implementation of the ACC et al. approach for splitting the rate base and sharing the benefits of jointly-used resources may be no less subjective or complex than the existing Phase III methodology.
However, the Commission is of the view that the ACC et al. approach has merit and is likely to evolve as competition develops in the industry. In this regard, the Commission notes that, in many respects, its method of regulation already reflects components of the ACC et al. approach through (1) increasing reliance on the use of transfer prices reflected in the CAT, (2) increasing levels of unbundled rates for services and activities, and (3) the treatment of broadband activities discussed in Part VI of this Decision. To the extent that it does not, the Commission concludes that the continued use of the Phase III approach is appropriate at this time.
b. Assignment of Joint-Use Costs
The Commission considers that there is some merit in the parties' positions regarding the need for some adjustments to the Phase III methodology, particularly with respect to certain billing-related operations.
In its evidence of 31 January 1995, Stentor proposed to assign billing activities for centralized mail remittance (bill payment) and postage costs to the Utility and Competitive segments using the approach proposed for assignment of Common costs. ACC et al. and Unitel addressed, among other things, the appropriate assignments of costs incurred with respect to integrated operations for billing and collection systems, processing and printing of bills, stuffing envelopes, collection of accounts receivable and postage.
Unitel also questioned the assignment of business office operations that are part of customer services operations, stating that competitors incur costs similar to those of the telephone companies for activities such as service order processing and billing and collection. In particular, Unitel noted that, when a customer is both a local subscriber and a toll customer of the same company, the recording of information such as name, address and billing information, and the collection of information with respect to service changes, is assigned to the Phase III Access category. In Unitel's view, the Phase III toll costs are therefore understated.
The Commission concludes that there is a requirement in some instances to refine the existing Phase III assignment processes to take into account the joint nature of certain billing and service order activities. Accordingly, the Commission has adjusted the companies' Split Rate Base results to reflect the following determinations:
(1) Costs related to postage and centralized mail remittance are to be assigned on a 50/50 basis to the Utility and Competitive segments.
(2) Costs of recording customer profile information for name, address and billing information, and bill printing costs are to be assigned on a 50/50 basis to the Utility and Competitive segments for 1995.
The Commission notes that, while each company's Phase III methodology takes into account its specific operations, the assignment procedures for particular sets of sub-activities for corporate processes, such as taking service orders, are not defined by each company. This has resulted in some companies adopting more discrete assignment methods than others.
Therefore, the telephone companies are directed to submit, by 15 January 1996, a general methodology (that takes into account the companies' operational differences) for the assignment of (1) costs of a joint nature relating to the service order expense associated with the recording of customer profile information for in and out orders and change of address activities, (2) the bill printing expense, and (3) other bill mailing costs that are common to both the Utility and Competitive segments.
6. Treatment of Access Tandem Connection and Other Equal Access Services
Equal access is currently provided under a bundled rate of 1.1 cents per minute (the 1.1 cent rate). Pursuant to Decision 94-19, the 1.1 cent rate was incorporated into the CAT.
In the proceeding initiated by Equal Access, Telecom Public Notice CRTC 94-26, 24 May 1994 (the Equal Access proceeding), the Commission is considering a number of applications for approval of tariff revisions related to the provision, on an unbundled basis, of the various service components required to provide equal access. On this basis, tariffed services would be available providing for connections to be made either at telephone company end office switches (Direction Connection service) or at their toll switches (Access Tandem Connection service).
In a 30 June 1995 submission in the Equal Access proceeding, Stentor proposed revised rates for the Equal Access services components. Stentor also proposed that Utility segment fixed and common costs be recovered through the use of a mark-up to establish appropriate charges to be paid by both the competitors and the telephone companies' Competitive segments.
In this proceeding, Stentor proposed that certain unbundled service components should be assigned to the Utility segment while other components, such as the proposed Access Tandem (AT) Connection service, should be assigned to the Competitive segment with rates set according to market conditions.
The Commission considers the following to be at issue in this proceeding: (1) the assignment of the AT Connection service, (2) the assignment of the telephone companies' use of toll connection trunks and related toll switching, and (3) the assignment of other proposed unbundled service components which Stentor assigned to the Competitive segment.
Most of the parties commenting on the assignment of the AT Connection service were of the view that it should be assigned to the Utility segment.
In Decision 92-12, the Commission determined AT Connection service to be a bottleneck service, although it recognized that, from a technical perspective, competitors could interconnect at the end office switch. The Commission considers that, in the long-term, competitive alternatives to AT Connection service may arise from local service competitors and from high-volume toll service competitors that use Direct Connection service, in conjunction with their own trunking and tandem switch to provide AT Connection service to other toll competitors.
In the Commission's view, this proceeding provided no persuasive reasons for changing the finding in Decision 92-12 that AT Connection service provided to IXCs is a bottleneck service. On that basis, the Commission concludes that AT Connection service provided to IXCs should be assigned to the Utility segment.
Stentor submitted that, if the AT Connection service was assigned to the Utility segment, the telephone companies' toll operations would consist largely of the resale of Utility segment services. The Commission notes, however, that the telephone companies would generally use Direct Connection service. Where such connections are used, the Commission is of the view that the costs for toll connecting trunks and related toll switching used by the telephone companies' Competitive segment should be assigned to the Competitive segment.
With respect to the other service components currently provided to IXCs under the 1.1 cent rate, the Commission is currently of the view that, when they are unbundled, the following services, which were proposed by Stentor to be assigned to the Competitive segment, should be assigned to the Utility segment:
(1) 800 Carrier Identification Query,
In this proceeding, the Stentor companies' Competitive segment included the costs for facilities between end office switches and toll office switches and the costs associated with toll office switches. Stentor proposed to allocate revenues derived from the 1.1 cent rate based on the use of Phase II costs (for example, Bell allocated 0.49 cents to the Utility segment and 0.61 cents to the Competitive segment).
Until unbundled rates are approved in the Equal Access proceeding, the Commission accepts this approach. The issue of mark-ups for the equal access services will also be dealt with in the Equal Access proceeding.
B. Other Split Rate Base Issues
1. Integrality of Directory Operations
In past proceedings, both under the Act and predecessor legislation, the Commission has determined that the directory-related activities of telephone company affiliates are integral to the telephone company's business and, in order to ensure that rates for telephone service are just and reasonable, has treated income from those activities as income of the telephone company for the purpose of determining its revenue requirement.
Section 33 of the Act states:
In this proceeding, the Stentor companies, except Manitoba Tel, argued that, with the advent of competition in directory services, some or all directory-related activities are not integral to the provision of basic telephone service and, therefore, some or all of the income related to these activities should be assigned to the Competitive segment.
BC TEL proposed to allocate revenues and expenses associated with the basic directory listings to the Utility segment and to allocate revenues and expenses associated with directory advertising provided in both White and Yellow Pages directories to the Competitive segment. Under BC TEL's proposal, the Competitive segment would pay the Utility segment for access to the listing database on the basis of the interim rates set in Provision of Directory Database Information and Real-time Access to Directory Assistance Databases, Telecom Decision CRTC 95-3, 8 March 1995 (Decision 95-3). BC TEL noted that, under its proposal, the directory operations would make the same level of contribution to the Utility segment as independent directory competitors.
In argument, BC TEL submitted that the issue under consideration in this proceeding is the determination of whether directory operations are, by nature, competitive or utility services. The company submitted that directory advertising is an advertising service in competition for the customer's budgeted advertising dollar, not just with similar telephone directories, but with all other advertising media. BC TEL also submitted that, if the Commission chose to look at directory advertising only in the context of telephone directory related services, directory advertising should nonetheless be assigned to the Competitive segment. In BC TEL's view, the fact that the company's directory operations may be in a dominant position in the market should not be determinative of whether the services are assigned to the Utility or the Competitive segment; but rather, whether a similar or substitute service is, or can be, practically provided by others. Finally, BC TEL noted that, with the rates set in Decision 95-3, its market share loss will be proportionally greater than the 5% which it estimated in the proceeding leading to that Decision.
AGT submitted that the Commission should completely abandon integrality as it relates to the Yellow Pages business of the Stentor companies. In AGT's view, this is particularly appropriate since, in Decision 95-3, the Commission removed the barriers to entry into the Yellow Pages business by requiring the company to provide subscriber listing information in machine readable form at a rate that does not include any contribution to the local access shortfall. In support of its view, AGT noted the rapid transition of the entire telecommunications industry to full competition.
In argument, Stentor, on behalf of Bell, MT&T, Island Tel, Newfoundland Tel and NBTel, proposed that, effective 1 January 1996, the Commission adopt a mechanism consistent with that set out in the directive with regard to ED TEL Communications Inc. (ED TEL) in Order-in-Council P.C. 1994-1779, 25 October 1994 (the ED TEL directive). Specifically, Stentor proposed to assign revenues and expenses associated with Yellow Pages directory activities to the Competitive segment and to make a contribution from the Competitive segment to the Utility segment equal to 18% of the Yellow Pages revenues, less an amount based on the tariffed rates for business customer listings. Stentor stated that, since the Commission removed significant barriers to entry into the Yellow Pages directory market, Yellow Pages will be a competitive business when tariffs are filed pursuant to Decision 95-3. Stentor noted that the telephone companies find the terms and conditions implicitly established in the ED TEL directive to be equally applicable and suitable for application to them at the present time, for the following reasons:
Stentor submitted that, with respect to the activity of directory advertising, neither condition of section 33 of the Act is met. In addition, Stentor noted that neither the companies' Terms of Service nor their general tariffs oblige them to provide directory advertising as an integral part of basic telecommunications service. Stentor further noted that directory advertising is not, and has never been a tariffed service.
Stentor also noted that the Act does not provide a definition of the term integral, and that Butterworth's Words and Phrases Legally Defined defines an "integral part" to be "... something which is necessary to the completeness of the whole". On the basis of this definition, Stentor acknowledged that the provision of basic listings in telephone directories is, in fact, necessary to the completeness of basic telephone service. However, it submitted that directory advertising is not necessary to the provision of basic telecommunications service; therefore, it can be concluded that it is not integral. Stentor suggested that the test to determine whether directory advertising is a competitive service is whether a similar or substitute service is, or can be, practically provided by others.
FNACQ/NAPO, fONOROLA, Sprint Canada and Unitel argued that revenues and expenses associated with directory activities should be assigned to the Utility segment and/or that directory activities are integral to the provision of basic service.
The Commission notes that the ED TEL directive only applies to that company, and is for the transitional period to federal regulation (commencing with the company's privatization and concluding in 1998). As well, the regulatory treatment of directory income specified in the ED TEL directive, broadly speaking, is consistent with its treatment prior to the transition to federal regulation.
The Commission also notes that the telephone companies' tariffs generally require them to provide telephone subscribers with both directory listings and White and Yellow Pages telephone directories as part of basic service. The basic listings in both directories are organized alphabetically (in the case of Yellow Pages directories, alphabetically within service and product categories), and the bold and other enhanced listings are co-mingled with the basic listings that are required to be provided as part of basic service. Consequently, the basic listings cannot be easily segregated from the enhanced ones. Moreover, enhanced listings contain the same information as, and in many cases replace, the basic listings in both the White and Yellow Pages directories. The Commission notes that other directory advertising (1) also forms part of the directories that are provided as part of basic service, (2) is found along with the basic listings within the same service and product categories, and (3) includes, in addition to other information, the information provided in the basic listings (i.e. subscriber names, addresses and telephone numbers).
As the Commission has found previously, the provision of directories, including directory listings and advertisements, facilitates the use of the telephone network by telephone company subscribers. The Commission considers that directories, including directory advertising, perform an essential role in enabling subscribers to identify and call others.
With respect to Stentor's submission that the telephone companies' Terms of Service and other portions of their general tariffs do not oblige them to provide directory advertising, the Commission agrees with Unitel that section 33 of the Act does not require an activity to be tariffed or form part of the telephone company's Terms of Service in order to be deemed integral.
The Commission also agrees with Unitel's argument that the existence of competition should not be the determining factor in the test of integrality and that section 33 of the Act does not specify that only non-competitive activities can be found to be integral.
The Commission remains of the view, stated previously in Decision 95-3, that the position of the telephone companies and their affiliates in the market is well secured through ownership of widely recognizable trade names such as "Yellow Pages". The Commission also agrees with the submissions of various parties (FNACQ/NAPO, fONOROLA and Unitel) that, because of the requirement to provide directories to all subscribers as part of basic service, the telephone companies' and their affiliates' directories will remain dominant in the provision of directory services for the foreseeable future.
In the Commission's opinion, based on the above, directory-related activities of the telephone companies' affiliates are generally integral to the provision of basic telecommunications service by the telephone companies. Further, the Commission considers that it must rely on its express power under section 33 of the Act to treat affiliate earnings from directory-related activities as if they were earnings of the telephone company in order to ensure that the telephone company's rates are just and reasonable.
In the circumstances, the Commission considers that revenues and expenses associated with directory activities should generally be assigned to the Utility segment.
In calculating contribution rates for 1995, the Commission has adjusted the companies' forecasts, as necessary, to reflect the above determinations.
The Commission notes the telephone companies' argument that, as a result of Decision 95-3, there will be increased competition in the provision of directory services in the future. The Commission considers that, as competition evolves, it would be appropriate to review the assignment of the directory operations between the Utility and Competitive segments and the extent, if any, to which affiliate earnings from directory-related activities should continue to be treated as if they were telephone company earnings for the purpose of ensuring that rates are just and reasonable.
2. Financial Issues
In Decision 94-19, the Commission considered it appropriate to reflect the relatively lower risk of the Utility segment in that segment's allowed ROE range for the transitional period. Accordingly, the Commission concluded that, for purposes of determining an allowable ROE range for the Utility segment, a downward risk adjustment of 50 basis points should be made to the mid-point of the current company-wide ROE range. The Commission also widened the allowed ROE range for the Utility segment to 200 basis points, 100 points on either side of the new mid-point.
In Decision 94-19, the Commission stated that it would consider, in the split rate base proceeding, any further risk adjustments to the Utility segment that parties may consider necessary, either in the form of changes to the capital structure used for regulatory purposes or by means of a further adjustment to the allowed ROE range. In Public Notice 94-52, the Commission also invited parties to address the issue of an appropriate cost of debt for the Utility segment.
b. Utility Segment ROE
Stentor and AGT argued that the developing industry risk profile supports the position that the relative total risk levels of the Competitive and Utility segments are virtually indistinguishable. Both parties stated that no downward risk adjustment should be applied in order to derive the ROE for the Utility segment. In contrast, AltaCC, BCOAPO et al., Calgary, FNACQ/NAPO and Unitel held the view that the 50 basis points downward adjustment to the company-wide ROE in arriving at a Utility segment ROE remains valid, in that the potential for competition in the local telecommunications market has yet to be determined and the Competitive segment remains riskier than the Utility segment.
Stentor argued that, because investors take a long-term view when making investment decisions and also view the risk levels of the two segments as converging in the future, the rates of return for the two segments should be identical.
The Commission notes that, in Decision 94-19, it concluded that any increase in the Utility segment's risk arising from competition in local services is likely to be minimal in the short run. The Commission remains of the view that the potential exists for meaningful competition in the local telecommunications market. However, the Commission also holds the view that competition is unlikely to develop during the transitional period to the extent found in the toll market and recognizes that investors would consider the period before meaningful competition exists when assessing the cost of capital for the Utility segment.
With respect to the widened ROE range, AGT submitted that capital market conditions have changed dramatically since AGT's most recent revenue requirement proceeding, and that to ignore this would negate the Commission's goal of ensuring a fair return for the company. The Commission has reviewed present capital market and economic conditions and remains of the view that the current widened ROE ranges for the Utility segments are appropriate.
AGT and Stentor pointed out that the approved company-wide ROE ranges do not reflect the significant overall increase in risk faced by the telephone companies today. It is the Commission's view that any increased risk faced by the telephone companies is, to a large extent, a result of competition in the long-distance market. Consistent with the new regulatory regime established in Decision 94-19, it is the Commission's intention to focus on the Utility segment and allow market forces to operate in the Competitive segment.
Therefore, the Commission recognizes that, although the potential exists for an increase in risk of the Utility segment at some point in the future, the downward risk adjustment of 50 basis points (to the company-wide ROE in arriving at a Utility segment ROE), enunciated in Decision 94-19, remains appropriate.
c. Utility Segment Capital Structure and Cost of Debt
Both Stentor and AGT recommended that the Commission use the company-wide capital structure and cost of debt as a useful and reliable estimate for the Utility segment. Dr. Morin recommended against the use of a deemed capital structure for the Utility segment for the following reasons: (1) there are no risk level differences between the Utility and Competitive segments, (2) there is little, if anything, to be gained from arbitrarily imputing more debt to a segment of a company, and (3) practical implementation problems associated with a fictitious capital structure are prohibitive. In light of its view that the business risk of the Utility segment is not less than that of the Competitive segment, Nesbitt Burns Inc. recommended that the capital structure of the Utility segment be no different from that of the total telephone company and that the capital structure should target a minimum 55% equity component. Further, Nesbitt Burns Inc. stated that a common equity ratio in the range of 55% to 60% would be appropriate.
As noted earlier, the Commission is of the view that there is a risk differential between the Competitive and Utility segments, but considers that the capital structure and the cost of debt, found to be generally appropriate in previous Commission decisions, is appropriate for the Utility segment.
The Commission views its conclusion on capital structure and cost of debt, along with the downward adjustment of 50 basis points to the company-wide ROE to arrive at the Utility segment ROE, as a fair reflection of the risk differential between the two segments and approves the use of the forecast company-wide capital structure for the Utility segment, provided that the common equity component does not exceed 55%. If it does, the telephone companies (with the exception of AGT) are directed to impute a maximum common equity component of 55%. The Commission notes that, for 1995, BC TEL's forecast common equity component exceeds 55% and has adjusted that company's split rate base results accordingly.
With respect to AGT, the Commission approved a common equity component of 60% in AGT Limited - Revenue Requirements for 1993 and 1994, Telecom Decision CRTC 93-18, 29 October 1993 (Decision 93-18), in recognition of the company's income tax status. In that Decision, the Commission also accepted the company's proposal to gradually reduce this common equity ratio to the level of the other Canadian telephone companies, when it incurs income tax. The Commission notes that AGT has reduced its common equity component and that, for 1995, AGT's forecast common equity component is slightly above 55%. For this reason, the Commission accepts AGT's forecast company-wide capital structure for the Utility segment for 1995.
CAC, FNACQ/NAPO, fONOROLA, Sprint Canada and Unitel argued that the plans of the Stentor companies to increase depreciation expense for copper cable and switching equipment are being driven by the Beacon Initiative, rather than by the continuing need to provide basic telephone service.
Stentor asserted that the future value of copper is rapidly being depleted because of technological change and open competition. Stentor submitted that competitors who provide broadband services will be able to offer narrowband service from their broadband platforms at lower cost than Stentor with copper technology.
Stentor also submitted that the reduction in average service life of Digital Multiplex Switching (DMS) is driven by technological changes within the DMS architecture, rather than by a need to implement ATM high capacity switching equipment.
Stentor stated that past embedded investments were prudently made under the rate of return regulatory principle that made provision for full capital recovery through rates. Stentor submitted that this regulatory principle was also used to establish basic local rates which are below cost and, therefore, the introduction of competition and convergence must not result in the shifting of capital recovery from the users of the assets. AGT's witness referred to the full recovery of capital assets as part of the "regulatory bargain".
As noted in Part VI dealing with broadband issues, the Commission considers that Utility segment subscribers should be isolated from the impact of the Stentor companies' broadband initiatives. Therefore, the Commission is not prepared, in general, to approve increases in depreciation expense that arise solely from the telephone companies' investment in broadband facilities. However, the Commission is of the opinion that there are circumstances which may arise during the transition to price caps where changes in depreciation life characteristics may be warranted, independent of any broadband initiatives. Accordingly, the telephone companies may apply on a case-by-case basis for approval of changes to their depreciation life characteristics within the Phase I depreciation directives, using the public processes open to them. The Commission notes that applications to significantly accelerate depreciation expense will entail a full review of the impact on rates. Further, any such applications may be assessed in light of any impact they may have on the initial price levels under price caps.
C. Company-Specific Issues
1. Manitoba Tel
a. Applicability of Decision 94-19
In Public Notice 94-52, the Commission noted that Manitoba Tel intended to provide a proposal in this proceeding to address issues related to the capital structure for its Utility segment, and evidence on the appropriate costs of equity and debt for this segment. In addition, Manitoba Tel was directed to take into account its status as a Crown corporation in its evidence concerning the application of earnings regulation to its Utility segment. In Public Notice 94-58, the Commission stated that, in light of concerns expressed by various parties, it would also include in this proceeding a consideration of whether Decision 94-19 should apply to Manitoba Tel. The Commission notes that, while certain parties put forth proposals related to the implementation of Decision 94-19, no party objected to the application of the general principles of that Decision to Manitoba Tel. The Commission considers it appropriate that Decision 94-19 generally apply to Manitoba Tel. The proposals relating to the implementation of that Decision have been dealt with throughout this Decision. The specific form of regulation for Manitoba Tel is discussed below.
b. Form of Regulation
Based on the evidence submitted on its behalf by Deloitte & Touche, Manitoba Tel proposed that, for the transitional period, its Utility segment be regulated using rate of return regulation with the following elements:
Manitoba Tel argued that it derives no competitive advantage from its status as a Crown corporation, and that it is in fact disadvantaged in the marketplace because of its capital structure. Manitoba Tel submitted that, during the transitional period, rate of return regulation should apply to its Utility segment on the basis of a deemed capital structure and an imputed cost of capital, with an allowed rate of return similar to that of other Stentor companies regulated by the Commission.
Manitoba Tel stated that, since it faces the same business risks as the privately owned telecommunications companies, it should have a similar capital structure, and should therefore increase its level of equity. Manitoba Tel maintained that, since its only source of equity is retained earnings, increasing its equity will take time.
Manitoba Tel proposed that the cost of debt for the deemed capital structure be determined using the company's embedded debt costs, including a portion of the debt guarantee fee (0.5% of the outstanding debt as at 31 March of the previous year) paid by Manitoba Tel to the Province of Manitoba. Under the former provincial regulator, the company had recovered this cost through approved rates. In addition, Manitoba Tel proposed that it be allowed to recover 70% of the debt guarantee fee.
CAC/MSOS also submitted a proposal for the regulation of Manitoba Tel during the transitional period. This proposal relied on a type of rate of return regulation, to be applied as follows:
Manitoba Tel argued that the CAC/MSOS proposal would prevent both local and long distance rates from moving towards cost and would not sever the link between the Utility and Competitive segments of the company. In addition, because the proposal would perpetuate pricing local services at levels substantially below cost, it would maintain a recognized barrier to competition in the local service market. Accordingly, in Manitoba Tel's view, the proposal was inconsistent with the broad policy underlying Decision 94-19.
The Commission generally agrees with Manitoba Tel's comments regarding the CAC/MSOS proposal and concludes that such a proposal would not be appropriate for regulating Manitoba Tel. With respect to CAC/MSOS' concern about Manitoba Tel's potential anti-competitive pricing behaviour, the Commission continues to be of the view expressed in Decision 94-19 that the imputation test for the pricing of competitive services serves as a safeguard against such behaviour. In this regard, the Commission notes that the use of a proxy income tax cost for the purpose of Manitoba Tel's imputation test is being considered in the proceeding initiated by Phase II Costing Issues, Telecom Public Notice CRTC 95-19, 20 April 1995.
The Commission agrees that Manitoba Tel should be subject to rate of return regulation on its Utility segment during the transitional period and endorses the company's goal of reducing the debt component of its capital structure over time. However, with respect to deeming a capital structure for the company, the Commission is of the view that establishing an allowed ROE for the Utility segment that recognizes the low common equity component of the actual company-wide capital structure is a better approach for permitting Manitoba Tel to achieve its goal of gradual debt reduction through retained earnings. Accordingly, the Commission denies Manitoba Tel's proposal that its Utility segment be regulated using a deemed capital structure. The Commission will regulate Manitoba Tel's Utility segment on the basis of its actual capital structure.
In setting Manitoba Tel's allowed Utility segment ROE, the Commission has taken into account the company's proposal regarding the corporate-wide ROE mid-point, Manitoba Tel's relatively low common equity component, its tax-exempt status as a Crown corporation, the Province of Manitoba's debt guarantee and a 50 basis point downward adjustment to account for the lower risk of the Utility segment. Based on these factors, the Commission considers a mid-point ROE of 11.88% for Manitoba Tel's Utility segment, with a range of 10.88% to 12.88%, to be appropriate. As determined in Decision 94-19, should the Utility segment achieve earnings above the upper limit of the allowed ROE range, the excess earnings will be applied to a deferral account to be cumulated over the transitional period.
Consistent with its determination not to deem a capital structure for Manitoba Tel, the Commission considers it reasonable to allow the company to recover the full debt guarantee fee paid to the Province of Manitoba relating to the Utility segment. In addition, the Commission considers it appropriate for Manitoba Tel to use the company-wide cost of debt for the Utility segment.
The Commission notes that, if Manitoba Tel meets its goal of increasing its common equity by 2% yearly, its common equity will increase to approximately 26% by the end of the transitional period. The Commission considers that this marginal increase in Manitoba Tel's common equity ratio would not, in itself, warrant any further adjustment to the company's allowed ROE for the Utility segment.
The Commission notes that the company's 1995 revenue requirement and contribution rate is not significantly altered by the combined effect of (1) using a Utility segment ROE of 11.88%, the actual capital structure and allowing the recovery of the full debt guarantee fee, instead of (2) using the company's proposal including a 50 basis point reduction to the ROE to reflect the lower risk of the Utility segment. This is in part due to the fact that, as a Crown corporation, Manitoba Tel is tax exempt. Because the company pays no income tax, the after-tax cost of equity is very close to the after-tax cost of debt. Finally, the Commission notes that, regardless of whether the actual or an imputed capital structure is used, Manitoba Tel can move towards a more conservative capital structure over time.
Following the transitional period, Manitoba Tel's Utility segment will be subject to price cap regulation, as determined for other Stentor members in Decision 94-19.
2. AGT - Income Tax Matters
In AGT - Issues Related to Income Taxes, Telecom Decision CRTC 93-9, 23 July 1993 (Decision 93-9), the Commission determined, among other things, that a shareholder entitlement to Additional Tax Deductions (ATDs) in the amount of $183 million would not be unreasonable. In Decision 93-18, the Commission approved AGT's proposed method for the recovery of the shareholder entitlement. The Commission directed AGT to file a revised recovery schedule, basing its calculations on the assumptions that (1) the line item "Revenue Increase (Including Stentor Settlement Plan (SSP))", would be limited to $30 million in 1994, and (2) that rates would not be increased in future years in order to recover the shareholder entitlement. This revised schedule was approved by the Commission in a letter dated 22 December 1993.
In Decision 93-18, the Commission also gave final approval to a local rate increase that had been granted on an interim basis effective 1 May 1993. Although this local rate increase was estimated to generate additional revenues of approximately $49 million in 1994, the Commission found that additional revenues of approximately $16 million (mainly from competitive services) was required in order for the company to recover its 1994 revenue requirement. This revenue requirement also included the shareholder entitlement expense of $30 million.
In its evidence of 31 January 1995, AGT considered that, consistent with the principles established by Decision 93-9, Decision 93-18 and City of Calgary - Application to Review and Vary Telecom Decisions CRTC 93-9 and 93-18, Telecom Decision CRTC 94-22, 4 November 1994 (Decision 94-22), the Utility segment (and therefore subscribers) should receive 100% of the benefits of the ATDs and bear 100% of the burden of shareholder entitlement; further, the amount of shareholder entitlement and tax expense for regulatory purposes would be adjusted in accordance with Decision 94-22, in the event of a reassessment by Revenue Canada of the amount of ATDs.
AGT stated that those expenses relating to ATDs determined by the Commission in Decisions 93-9, 93-18 and 94-22 should not be included in AGT's contribution requirement. In particular, AGT proposed that the difference resulting from a reassessment of the amount of ATDs relative to the company's filing position, and amounts relating to shareholder entitlement (as adjusted by Decision 94-22 in the event of reassessment) not be included in AGT's contribution requirement. Similarly, AGT submitted that those amounts of normalized tax expense that arise in the future in respect of the Utility segment not be included in the calculation of the contribution requirement.
With respect to the allocation of the benefits of the ATDs, the Commission agrees with AltaCC and Calgary that the ATDs stem from assets and operations of the company used to provide both Utility and Competitive segment services. The Commission notes that, in AGT Exhibit 21 (which provided responses to several Commission questions), AGT acknowledged that tax deductions would normally be expected to follow assets. The company stated that its position that the Utility segment should receive 100% of the benefits of the ATDs was predicated on the shareholder entitlement being allocated 100% to the Utility segment and excluded from the contribution component of the CAT. In the Commission's view, given that the majority of these ATDs flow from assets that are assigned to both the Utility and Competitive segments, AGT's rationale for assigning the benefits of the ATDs entirely to the Utility segment is without merit.
With respect to the shareholder entitlement, AGT argued that the Utility segment is not recovering the shareholder entitlement, since Utility segment revenues (excluding the CAT) do not recover Utility segment expenses (including the shareholder entitlement). The Commission notes that Utility segment revenues do not recover Utility segment expenses, even when the shareholder entitlement is excluded. Thus, the fact that the contribution component of the CAT must recover the Utility segment shortfall (including the shareholder entitlement) is not a valid reason to exclude the shareholder entitlement from the contribution calculation. Rather, the Commission considers that the shareholder entitlement expense forms part of the Utility segment revenue requirement, as do other expenses (such as depreciation, advertising, etc.), and should be included in assessing the Utility segment shortfall and the associated contribution level.
In response to a Commission interrogatory, AGT stated that, given its forecast corporate-wide ROE for 1995, any neutralizing effect of the rates set by Decision 93-18 is no longer sufficient to ensure that the shareholder entitlement will be borne by subscribers through rates. The Commission notes that ML revenues are forecast to increase from 1994 to 1995, despite the company's forecast corporate-wide ROE. In the Commission's opinion, this demonstrates that ML rates set by Decision 93-18 are more than sufficient to ensure that the shareholder entitlement will be borne by subscribers through local rates.
In addition, the Commission notes that local service rates were already increased in 1994 to offset the increase in the revenue requirement caused by the recovery of the shareholder entitlement. As stated in Decision 93-18, the schedule proposed by AGT for the future recovery of the shareholder entitlement was to be based on the assumption that rates will not be increased further in future years. The Commission considers AGT's proposal to exclude the shareholder entitlement from the contribution calculation, while including it as an expense in the Utility segment, would result in further local rate increases that would generate revenues in excess of those required to recover the shareholder entitlement over the approved recovery schedule.
With respect to the assignment of the shareholder entitlement expense, the Commission notes that the shareholder entitlement recovery schedule was based on the assumption that the revenue in the line item "Revenue Increases" was to come from local service rates. Local service revenues are assigned to the Utility segment. The Commission also notes that this schedule included a positive SSP revenue impact (line item "SSP Recovery") resulting from the treatment of the shareholder entitlement as income tax expense for SSP recovery purposes. This settlement impact is assigned to the Competitive segment.
In the Commission's view, the allocation of the shareholder entitlement expense between the Utility and Competitive segments on the basis of the ratio of the amounts in each of the first two lines ("Revenue Increases" and "SSP Recovery") to the amount in line item "Revenue Increase (Including SSP)" of the recovery schedule would provide a better matching of the recovery of the cost of the shareholder entitlement. It would also make the shareholder entitlement transparent to the financial performance of each segment. For the year 1995, this would result in an allocation of the shareholder entitlement of $29.1 million to the Utility segment and $4.1 million to the Competitive segment.
The Commission also notes that AGT has indicated (in another proceeding) that Revenue Canada will shortly issue a reassessment of its 1990 income tax return. This reassessment may significantly reduce the amount of ATDs available and, consequently, may affect the Commission's treatment of income tax issues for split rate base purposes for 1996. However, the Commission would expect that the principles enunciated in this Decision would apply to any reassessment and future Utility segment income tax expense.
In light of the above, the Commission directs that:
The Commission has adjusted AGT's split rate base results for 1995 to reflect the above determinations.
D. Split Rate Base/Phase III Results and Procedures
1. Updates to Phase III Manuals
Revised procedures will be required to reflect the changes to the Phase III methodology directed by the Commission earlier in this Decision, such as the reassignment of certain bottleneck services, customer postage, centralized mail remittance, PUC, income tax, CAT revenue and cost inputs and the allocation of the Common category. With the exception of the procedures relating to the assignment of broadband facilities (previously noted), the Commission considers that all split rate base related updates to Phase III Manuals can be submitted using the regular Phase III update filing procedures. The Commission directs the companies to file the related updates in the 15 January 1996 Phase III Update filing.
2. Competitive Segment Use of Utility-Related Facilities at Tariffed Rates
In its split rate base proposal, Stentor submitted that for certain cases where the function or facility of one segment is also required by the other segment, tariff rates should be used to match revenues with costs. For example, Stentor treated the CAT as a cost to the Competitive segment and as revenue for the Utility segment.
Similarly, Stentor proposed that there are competitive services, such as Call Answer, that utilize local switching facilities for which the tariffed rates will be recorded as Utility segment revenues and Competitive segment costs. The Commission finds this approach acceptable.
Stentor further indicated that there are competitive private line and data services which utilize the intra-exchange network. Stentor proposed that unbundled local loop tariff rates, when approved, be recorded as Utility segment revenues and Competitive segment costs. Further, all costs and revenues currently assigned to the Access - Other sub-category, except those relating to unbundled Utility segment function or facilities such as the loop, would be assigned to the Competitive segment.
The Commission finds the foregoing approach to be generally acceptable and approves it in principle.
The Commission is of the view that appropriate reporting procedures should be implemented to ensure the appropriate tracking of the revenue and cost streams that arise from the use of tariffed rates. Accordingly, the companies are directed to submit at the time of the filing of the regular 15 January 1996 Phase III Updates, a proposal for the tracking of costs and revenue streams that will ensure the auditability of the split rate base results.
The Commission notes that the treatment of costs and reliance on tariffs or transfer pricing related to new broadband investment is dealt with in Part VI of this Decision.
3. Presentation of the Split Rate Base/Phase III Results
The Commission has determined that the split rate base results are to be reported for the Utility and Competitive segments in a format set out in Attachment B to this Decision. The statement formats in Attachment B are based on Bell's accounting system terminology as an illustration; the other telephone companies may make modifications where their terminology differs from that of Bell. These results are to include a supporting schedule indicating the distribution of Common costs to the Utility and Competitive segments. As previously noted, a supporting schedule is also required for broadband facilities (as described in Part VI of this Decision). These split rate base results and supporting schedules are to replace the current filing requirements for Phase III.
Those companies that have reported Phase III Access sub-category results are directed to maintain the capability of producing such results, at least until the price cap regime has been implemented. However, there will be no requirement to submit quarterly updates to Phase III procedures or annual audited and forecasted results for these sub-categories.
In Public Notice 94-52, the Commission indicated that, with respect to contribution charges, this proceeding should be confined to an examination of contribution estimates and supporting information, as was the case in the 1994 contribution charge proceeding. It was also indicated that issues such as reductions in contribution discounts and the surcharge for Direct Access Lines (DALs) were beyond the scope of the proceeding.
B. Minute Forecasts
Stentor argued that the evidence submitted in this proceeding illustrates that the companies' previous forecasts of total minutes have been well within the bounds of reasonable forecast error. Stentor also submitted that, if the Commission considers an adjustment to a company's forecast of entrant minutes necessary, a countervailing adjustment should be made to the company's forecast of its own minutes, unless the Commission is of the view that the company's estimate of total market minutes also requires adjustment.
The Commission accepts the minute estimates of ACC, Cam-Net, fONOROLA and Unitel for 1995 as they are projecting growth rates that are not unreasonable, given past growth and their positioning in the market.
The Commission notes that, on 3 August 1995, Sprint Canada announced that it had purchased the operations of Smart Talk Network (STN). The Commission considers it appropriate that STN's minute forecasts be included in the calculation of contribution, since it is likely that a high proportion of these minutes will have been picked up by Sprint Canada. With respect to STN's minute forecast, the Commission has adjusted the 1995 estimate downwards by 30%, based on past projections versus actual growth performance.
The Commission notes that Sprint Canada acknowledged in response to a Commission interrogatory that it has over-forecasted its minutes in the past. This is supported by the Commission's own analysis of Sprint Canada's estimates and actuals. Accordingly, Sprint Canada's 1995 estimate has been adjusted downwards by 15%.
In addition to the above changes, in order to arrive at an estimate of the total entrants' minutes, the Commission has adjusted the total entrant switched originating and terminating minute forecast (line 3a in Attachment C to this Decision) upwards for Bell and BC TEL territories. This adjustment is necessary in order to reflect non-reporting resellers who carry contribution-eligible minutes in those territories. In making this determination, the Commission has also taken into account the reconciliation between respondent originating and terminating switched minutes and entrant minutes.
Total market size in the calculation will be affected by these adjustments to the line 3a minutes. However, the Commission is of the view that, with the exception of AGT and Manitoba Tel, no adjustments are necessary to the estimate of respondent switched originating and terminating minutes (line 2).
In the case of AGT and Manitoba Tel, the Commission considers that the line 2 minutes should be increased with a corresponding decrease in line 3a minutes to take into account over-estimation of market share loss. In the case of AGT's territory, the Commission has determined that, based on 1994 actual entrants' minutes compared to total market size, entrants did not achieve as great a share of minutes as expected. Based on this, the Commission does not accept AGT's market share loss projections for 1995, and considers that the downward adjustment to the line 3a minutes should be offset by an increase in AGT's own minutes, thereby leaving the total market size unchanged.
The Commission notes that Manitoba Tel predicted a 1995 market share loss of 14%, based on originating conversation minutes. The Commission considers this to be an over-estimation, since competition was only recently introduced in its territory and equal access was available only in the second half of 1995. Accordingly, the Commission finds that, as in the case of AGT, the downward adjustment in the entrant minute estimate should be offset by an increase in the respondent minute estimate, thereby leaving the total market size unchanged.
The minute estimates used by the Commission to calculate the 1995 contribution charges can be found in Attachment C to this Decision.
C. Settlement Adjustment
In Decision 92-12, the Commission concluded that the level of contribution for each Stentor company should be based on the non-toll deficit prior to settlement; therefore, the contribution level was to be adjusted to reflect the estimated amount associated with revenues settled between members of Stentor through the SSP. In Public Notice 94-52, the Commission asked the telephone companies to address the appropriate treatment of the settlement adjustment. In particular, the Commission directed the telephone companies to provide a rationale for retaining the settlement adjustment, in light of the requirement to break the link between toll and local rates and given that contribution charges are to be based on the Utility segment revenue requirement.
Stentor eliminated the settlement adjustment when calculating the 1995 proposed contribution charges. Stentor stated that, since the contribution requirement is no longer tied to forecast results associated with the competitive toll market, a settlement adjustment is not meaningful or appropriate.
In response to an interrogatory, Stentor stated that the contribution rate is predicated on a contribution requirement associated with the results of the Utility segment. Accordingly, it submitted that it would be inappropriate to include revenues from the SSP in calculating the contribution requirement. Stentor noted that including the effects of the settlement adjustment would increase contribution rates for AGT and BC TEL, and reduce contribution rates for Manitoba Tel and MT&T.
Sprint Canada agreed with Stentor that it would be inconsistent with the intent of Decision 94-19 to incorporate in the definition of the 1995 contribution requirement a component that is directly related to the performance of the Competitive segment. Sprint Canada submitted that it would not be appropriate to implement the split rate base using a contribution methodology that (1) prolongs the link between toll and local rates into 1995, and (2) does not accurately reflect each telephone company's cost structure, contribution requirement, and financial ability to support past and forecast toll rate reductions.
Unitel submitted that, if the Utility segment's shortfall is not reduced by settlement receipts, the shortfall would therefore be larger than under the existing regulatory regime for those companies that receive net settlements. Unitel proposed that the 1994 contribution level cap be lifted for 1995, allowing contribution rates to increase for those companies that received net settlements pursuant to the SSP. Given that this would lead to 1995 contribution rates being higher than 1994 rates, Unitel submitted that long distance rates should be increased where those rates fail the imputation test (as calculated with the higher contribution rates).
The Commission agrees with Stentor's position that the removal of the settlement adjustment from the calculation of contribution is required to break the link between toll and local rates. The Commission also agrees with both Stentor and Sprint Canada that the settlement adjustment is directly related to the performance of the Competitive segment.
The Commission concurs with Stentor's proposal to eliminate the settlement adjustment from the outset of the split rate base regime, rather than at some point in the future. The Commission considers this to be consistent with the objectives of Decision 94-19; to put off breaking this link would only complicate the transition to price caps.
However, with respect to the contribution ceiling, MT&T, NBTel and Newfoundland Tel would have contribution rates in excess of the contribution ceiling imposed under Decision 94-19, if the Commission were to establish rates such that the companies could earn an ROE at the mid-point of their allowed range. Newfoundland Tel's situation is exacerbated by the fact that, while the total company ROE for 1995 is estimated to be 11.5%, the Utility segment ROE is forecast to be 1.2%, well below the allowed range.
The Commission notes that the Decision 92-12 treatment of the settlement adjustment has reduced Newfoundland Tel's contribution requirement in previous years, which in turn has contributed to Newfoundland Tel having the lowest contribution rate of any of the Stentor companies. The Commission also recognizes that, coupled with the requirement under Decision 94-19 that contribution rates not increase, this contribution rate would yield a Utility segment ROE well below the allowed ROE range for 1995.
In light of the above, the Commission directs Newfoundland Tel to freeze contribution charges at 1994 levels, while at the same time implementing rate rebalancing directives set out in Part IV of this Decision. The Commission notes that, with contribution frozen, rate rebalancing for Newfoundland Tel will include local rate increases and toll rate decreases and will not include a reduction in the contribution rate. The freeze is to be removed once the Utility segment ROE is forecast to equal or exceed the mid-point, or will be reviewed with the implementation of price caps.
With respect to MT&T and NBTel, the Commission does not consider it appropriate to freeze contribution charges. While their contribution rates will be capped at the 1994 levels, these companies are directed to lower their contribution charges when implementing the Commission's rate rebalancing directives. The Commission notes that MT&T received an interim local rate increase in 1995, and that the Commission is permitting it to increase local rates effective 1 May 1996 (rather than 1 January 1996) in the rate rebalancing initiatives ordered in Part IV of this Decision, should final approval be granted. Finally, the Commission notes that the contribution rates of MT&T and NBTel are significantly greater than the rate of Newfoundland Tel.
D. Treatment Of Shortfall Caused By Discounts
In Decision 92-12, the Commission required all competitors entering the market to pay a contribution charge for each access trunk interconnected to the public switched telephone networks (PSTNs) of the telephone companies. The per-trunk contribution collection mechanism was based on a per-minute amount of contribution required and on certain assumptions regarding the amount of traffic that could be carried over a trunk. Further, the Commission considered that a contribution discount was appropriate, because the telephone companies held a market advantage over all competitors in the long distance market as a result of their control of the local networks and their historically dominant position.
In Decision 94-19, the Commission determined that a per-minute contribution charge would be more suitable than the per-trunk charge, as it would, among other things, result in greater equity among all competitors in the long distance market. However, the Commission acknowledged that the average per-minute charge might create disincentives for competitors to carry low-margin traffic, such as off-peak residential traffic, and that it may be necessary to consider de-averaging contribution charges.
On 30 September 1994 and 3 October 1994 respectively, Unitel and Sprint Canada filed applications to review and vary that part of Decision 94-19 applying a per-minute contribution charge to competitors utilizing trunk-side access to the PSTN. Unitel and Sprint Canada also requested a stay of that part of Decision 94-19.
On 29 December 1994, the Commission issued Applications by Unitel Communications Inc. and Sprint Canada Inc. To Review and Vary Part of Decision 94-19, Telecom Decision CRTC 94-27 (Decision 94-27). In Decision 94-27, the Commission noted that the applicants and certain other parties filed evidence indicating that an average per-minute contribution charge at current contribution levels would have a significant negative impact on the incentives for competitors to serve the off-peak (low-margin) market. These submissions raised concerns on the Commission's part regarding the negative impact of the average per-minute contribution mechanism adopted in Decision 94-19 on the level of competition in the residential consumer market. Accordingly, the Commission found that a review of Decision 94-19 was warranted with respect to the implementation of an average per-minute contribution charge and with respect to the timing of the change in the contribution mechanism. However, the Commission remained of the view that a move from a per-trunk to a per-minute mechanism is necessary.
In Decision 94-27, the Commission considered that a de-averaged per-minute contribution mechanism could provide a reasonable means of reconciling the need to move to a per-minute mechanism with the need for appropriate incentives for competition in the off-peak market. Accordingly, in De-Averaged Per-minute Contribution Mechanism, Telecom Public Notice CRTC 94-59, 29 December 1994 (Public Notice 94-59), the Commission initiated a proceeding to consider its proposal for a de-averaged per-minute contribution mechanism and the impact associated with its implementation. Until a final determination is made with regard to the Commission's proposal, trunk-side connections of IXCs and resellers will continue to be charged contribution on a per-trunk basis.
By letter dated 8 May 1995, the Commission informed parties to the proceeding initiated by Public Notice 94-59 that any decision the Commission may make with regard to a de-averaged per-minute contribution mechanism will not be implemented before 1996.
The Commission notes that, in Public Notice 94-52, the Commission limited the scope of the split rate base proceeding with respect to issues relating to contribution charges. The Commission stated that this component of the proceeding should be confined to an examination of contribution estimates and supporting information, as was the case in the 1994 contribution proceeding. Accordingly, in the Commission's view, it was clear from the outset that the contribution component of the split rate base proceeding was to be limited to a straightforward assessment of the inputs to the contribution methodology set out in Decision 94-19 and the calculation of contribution rates using this methodology.
The Commission further notes that, by letter dated 21 March 1995, it declared certain evidence filed by CBTA, Sprint Canada and Unitel to be beyond the scope of this proceeding, noting, among other things, that the evidence in question dealt with the methodology for calculating contribution charges.
In light of the above, the Commission finds the treatment of implicit contribution discounts to be outside the scope of the proceeding. Accordingly, in this Decision, the Commission makes no determinations with respect to this issue. The Commission continues to be of the view that the contribution discount schedules established in Decision 92-12 are appropriate.
The Commission notes that the application filed by Stentor on 3 August 1995, regarding the 1995 calculation of per-circuit contribution rates will be dealt with in a separate proceeding.
E. 1995 Contribution Rates
Based on determinations made throughout this Decision, the Commission gives final approval to the following contribution rates (with the exception of AGT's rate):
Line 5c) (non-Discounted)
1995 Contribution Per Minute Per End ($)/
1994 1995 change
BC TEL 0.0621 0.0449 -27.7%
AGT's interim rate (as set out in Final 1994 and Interim 1995 Contribution Charges, Telecom Decision CRTC 95-4, 31 March 1995) will remain interim (as of 1 January 1995) until the Commission renders a decision regarding the matters raised in the proceeding initiated by Contribution Regime in Alberta, Telecom Public Notice CRTC 94-51, 26 October 1994. The calculation of 1995 contribution charges are shown in Attachment C to this Decision.
Finally, the companies are directed to issue, by 30 November 1995, tariff pages incorporating the per-minute charges approved in this Decision. These rates are to take effect 1 January 1995, with the companies (except AGT) proceeding with billing adjustments as expeditiously as possible.
Allan J. Darling
RECONCILIATION OF COST ESTIMATES
A reconciliation of Unitel's estimates of AT&T-C and Bell costs to Stentor's estimates (submitted by the parties in final argument) are illustrated in the following tables (minor differences occur due to rounding):
AT&T-C Toll Costs
Cts/Min Reference: Part II of this Decision
Unitel's Estimate 9.9 Section A.2
Bell Phase III CT Costs
Cts/Min Reference: Part II of this Decision
Unitel's Estimate 7.0 Section A.2
Page 1 of 2
SRB SURPLUS/SHORTFALL REPORT
UTILITY COMPETITIVE TOTAL
1. OPERATING REVENUES
Page 2 of 2
SRB AVERAGE NET INVESTMENT BASE STATEMENT
UTILITY COMPETITIVE TOTAL
1. Telephone Plant
(Prior to Adjustments)
SRB CAPITALIZATION REPORT
UTILITY COMPETITIVE TOTAL
AVERAGE COMMON EQUITY
RETURN ON AVERAGE COMMON EQUITY REPORT
UTILITY COMPETITIVE TOTAL
NET INCOME TO COMMON
CALCULATION OF CONTRIBUTION - 1995
BC TEL AGT Man. Tel Bell NBTel MT&T Island Tel Nfld Tel
A. Contribution Requirement ($ Millions):
1. Level of Contribution Requirement 366.8 255.2 88.8 1,304.3 89.6 104.6 9.7 60.4
B. Toll Minutes Calculation (Millions):
2. Telco Orig. & Term. Minutes 6,770.8 5,270.4 1,795.4 25,036.0 1,278.3 1,356.7 183.9 811.3
C. Multiplicative Adjustments:
6. Gross Receipts Tax 1 1 1 .096 1 1 1 1
* 1995 Contr. Per Min. Per End is the lesser of lines 5a) or 5b).