NOTICE ********************************************************* NOTICE ********************************************************* This document was originally prepared in Word Perfect. If the original document contained-- * Footnotes * Boldface & Italics --this information is missing in this version The document format (spacing, margins, tabs, etc.) is changed too. If you need the complete document, download the Word Perfect version. For information about downloading documents (FTP) see file how2ftp. File how2ftp (.txt & .wp) is in directory \pub\Public_Notices\Miscellaneous. ************************************************************** *** ******** $// MO&O; Ameritech 5.3 X-Factor; DA 95-1611 //$ $/ Section 0.291 Delegated Authority /$ TRANSMITTED FOR FCC RECORD ONLY Before the FEDERAL COMMUNICATIONS COMMISSION Washington, D.C. DA 95-1611 In the Matter of ) ) Annual 1995 Access Tariff Filings ) ) Ameritech Petition Regarding Election ) of 5.3 X-Factor for Application ) Back to January 1, 1995 ) MEMORANDUM OPINION AND ORDER Adopted: July 18, 1995 ; Released: July 18, 1995 By the Chief, Common Carrier Bureau: I. INTRODUCTION 1. On May 9, 1995, the Ameritech Operating Companies (Ameritech) filed a petition with the Commission asking for "clarification" of the Commission's price cap rules to permit it to adjust its price cap indices (PCIs) to reflect the effect of advancing the application of the 5.3 percent X-Factor from August 1, 1995 to January 1, 1995. In the alternative, Ameritech requests a waiver of the Commission's rules to do so. Ameritech proposes to make a temporary, downward adjustment to its PCIs for the 1995 access tariff year to reflect the revenue effect of a 5.3 percent X-Factor adjustment for the first half of 1995. In exchange for this reduction in its PCIs for the upcoming tariff year, Ameritech asks that it not be subject to any sharing obligation with respect to its earnings during the 1995 calendar year. For the reasons discussed below, we agree with Ameritech that subjecting a local exchange carrier to a sharing regime during part of a year and a no-sharing regime during the balance may create incentives for the carrier that do not serve the public interest. We do not accept, however, the standard that Ameritech proposed in its waiver for granting the relief it seeks. Accordingly, although we deny Ameritech's waiver as filed, we set forth in this Order the conditions under which we would grant the relief requested by Ameritech. II. BACKGROUND 2. The price cap index, or PCI, is adjusted each year based on a measure of inflation that reflects productivity gains and price changes in the national economy, minus an X-Factor. The X-Factor is a number that reflects the amount by which the growth in telephone carriers' unit costs have historically been lower than the level of inflation for the national economy. The X-Factor is used in the price cap formula to ensure that rates continue to decline in relation to the economy as a whole. It is also intended to generate incentives and opportunities for local exchange carriers (LECs) to achieve higher productivity levels. 3. In the LEC Price Cap Review Order, the Commission amended its rules to establish a minimum X-Factor of 4.0 percent, with two optional X-Factors of 4.7 and 5.3 percent. LECs selecting the 4.0 and 4.7 percent X-Factors are subject to sharing requirements. The sharing mechanism requires a LEC to return to customers its earnings in excess of certain levels, including interest, through a temporary reduction in the LEC's rates in the next annual access period. The amount of the rate reduction is determined by a temporary adjustment to the LEC's PCI, which is calculated in the same manner as other exogenous changes to the price cap formula. When applied to the revised X-Factors, the sharing mechanism effectively permits a LEC selecting the 4.0 percent X-Factor to reach a maximum 12.75 percent rate of return. Likewise, a LEC selecting and outperforming an X- Factor of 4.7 percent can realize at most a 14.25 percent rate of return. 4. The Commission determined that LECs selecting the 5.3 percent X-Factor under the interim plan should not be subject to a sharing requirement. It reasoned that, although the 5.3 percent X-Factor represents a "major challenge" to most LECs, the most efficient ones will opt to use the higher factor if they are permitted to retain all the profits earned, rather than be subject to a sharing requirement. The Commission determined that this revision to its price cap plan will encourage continued movement away from rate-of-return regulation. 5. A LEC that selects the 5.3 percent X-Factor beginning with its 1995 annual access filing will not be subject to sharing obligations based on its earnings during the 1995 annual access tariff year. Such a LEC, however, remains subject to the sharing requirements in its 1996 annual access filing because a LEC's sharing obligations for the 1996 access year are based on its 1995 calendar year earnings. Since all LECs were subject to sharing requirements during the first six months of 1995, based on the X-Factor they selected in their 1994 annual access tariff filings, their performance during that part of 1995 may cause them to incur sharing and add-back obligations for the 1996 annual access tariff year. 6. LECs subject to price cap regulation were required to implement the new X-Factor and sharing rules in their 1995 annual access tariff filings. The Common Carrier Bureau (Bureau) rescheduled the effective date for the price cap LECs' 1995 annual access filings from July 1, 1995 to August 1, 1995, to allow them to do so. The Bureau required LECs to make a one-time adjustment to their proposed PCIs to account for the one month delay in the effective date of the 1995 annual access filings. III. SUMMARY OF PLEADINGS A. The Ameritech Petition 7. Ameritech contends that the application of the 5.3 percent X-Factor in its 1995 annual access tariffs, when combined with other required index changes, will produce rate reductions to its customers of about $66 million. If its petition is granted, Ameritech asserts that it will make an additional temporary downward adjustment to its PCIs and refile its annual access rates to reflect the dollar amount of the reduction in rates that advancing the effective date of the 5.3 percent X- Factor to January 1, 1995 would have had. According to Ameritech, this would provide its customers with an additional rate reduction of $26.5 million. In return, Ameritech asks to be relieved of all sharing obligations for the 1995 calendar year, regardless of what its 1995 earnings eventually amount to. Ameritech seeks clarification that the Commission's rules and orders permit such an election. In the alternative, Ameritech requests a waiver from the Commission to make such an election. 8. Ameritech asserts that grant of its waiver proposal is good for its customers. It explains that the index changes resulting from its proposal would bring about immediate rate reductions in all of its rate categories. Moreover, it asserts, the proposal is consistent with the Commission's decision in the LEC Price Cap Review Order. 9. The Common Carrier Bureau issued a public notice establishing a pleading cycle for comments and replies. Five parties filed comments in response to Ameritech's petition: AT&T Corporation (AT&T); Bell Atlantic Telephone Companies (Bell Atlantic); LDDS Communications, Inc., d/b/a LDDS WorldCom (LDDS); Pacific Telesis (on behalf of Pacific Bell and Nevada Bell)(PacTel); and Sprint Corporation (Sprint). Ameritech and AT&T filed replies. Letters in support of Ameritech's petition were also filed with the Commission by BN1 Telecommunications, Inc.; Cherry Communications, Inc.; Coast to Coast Telecommunications; Regulatory Services, Consolidated; Long Distance of Michigan, Inc; and MIDCOM Communications, Inc. B. Comments 10. All parties filing comments support granting Ameritech's petition for waiver. Both PacTel and Sprint assert that their LECs, too, could benefit from a similar waiver. LDDS supports granting a blanket waiver for all LECs choosing the 5.3 percent X-Factor. AT&T, however, argues that granting a similar waiver to other carriers would not produce the same benefits for their access ratepayers as the benefits that would be produced by retaining the sharing obligation for the period from January to July 1995. Sprint supports Ameritech's petition for clarification, while AT&T and LDDS assert that the LEC Price Cap Review Order does not appear to allow such an election. 11. The commenters assert that granting the waiver request is in the public interest. Bell Atlantic, LDDS and PacTel assert that Ameritech's proposal is consistent with the Commission's policies. Bell Atlantic, LDDS and Sprint argue that interexchange carriers (IXCs) would realize an immediate reduction in the interstate access rates they pay Ameritech, whereas the sharing mechanism would delay rate refunds to the IXCs. Bell Atlantic and Sprint assert that administrative complexities or ambiguities brought about by the "transition" period's partial year 1995 sharing obligations could be avoided. Sprint contends that allowing a January 1, 1995 effective date for the 5.3 percent X-Factor will motivate Ameritech to make additional productivity gains, which, it contends, would benefit ratepayers. 12. AT&T claims that ratepayers would not be harmed if the waiver is granted. According to AT&T, the purpose of the sharing mechanism is to mitigate the harm to access ratepayers from a LEC's understated productivity offset (i.e., its selection of an X-Factor lower than is appropriate for its productivity level) by implementing a temporary prospective reduction in the carrier's price cap indices. It asserts that applying the 5.3 percent X-Factor to Ameritech's PCIs back to January 1 approximates the amount of Ameritech's anticipated sharing obligation. It concludes that ratepayers will not be harmed if the waiver is granted. 13. AT&T and Bell Atlantic suggest modifying Ameritech's proposal. AT&T urges the Commission to require Ameritech to maintain the reduced rates for the duration of the 1995 tariff year as a condition for granting Ameritech's waiver. It also asks the Commission to clarify that Ameritech's procedure is a temporary adjustment to its PCIs, not a retroactive adoption of a 5.3 percent productivity factor, which would permanently affect Ameritech's price cap levels. Bell Atlantic asserts the adjustments to Ameritech's indices to apply the 5.3 percent X-Factor back to January 1, 1995 should be based on six months, not seven, as Ameritech proposes, because the Commission has already required LECs to adjust their indices to account for the one month delay in the effective date of the 1995 annual access tariffs. C. Replies 14. Ameritech and AT&T assert that the Ameritech proposal advances the elimination of the Commission's backstop mechanism. They argue that access customers and the public would reap the benefits of pure price cap regulation sooner than otherwise would occur if Ameritech's petition is granted. Ameritech claims that the uniform support of its request by large and small carrier customers reflects their belief that up-front rate reductions are sufficient compensation for eliminating future rate reductions that might result from sharing. 15. Ameritech asserts that replacing an uncertain sharing obligation reflecting future earnings with the certainty of an immediate rate reduction is a reasonable trade-off for Ameritech and its IXC customers. It claims that it will face unprecedented circumstances in 1995. It argues that the implementation of unbundling and other steps recently taken in Illinois and Michigan will create unique opportunities for IXCs to utilize the services of companies other than Ameritech. Ameritech argues that these steps are particularly significant given the concentration of its access business in the major urban areas of those states. 16. AT&T asserts that Ameritech's application of the 5.3 percent X-Factor on January 1, 1995 yields a rate reduction that approximates Ameritech's sharing obligation -- i.e., is revenue neutral -- only by coincidence. It contends that any subsequent applications filed by LECs requesting a waiver similar to Ameritech's must be considered on an individual basis because the neutrality of Ameritech's proposal is simply coincidental. For similar reasons, AT&T argues that the Commission should not implement Bell Atlantic's suggested "correction" to apply the productivity factor to six months rather than seven, because such a revision would disturb the balance between Ameritech's proposed immediate rate reductions and the amount of its estimated sharing reduction. D. Ameritech Ex Parte Statement 17. On June 5, 1995, Ameritech filed an ex parte statement summarizing its June 2, 1995 presentation to representatives of the Common Carrier Bureau. It argues that grant of the waiver would further the Commission's goals by giving full effect more rapidly to the 5.3 percent "no-sharing" X-Factor, thus bringing the benefits of "pure" price cap regulation more quickly to consumers. Ameritech also contends that 60 percent of its access revenues are in Illinois and Michigan, which are subject to unbundling orders. It asserts that AT&T, Sprint and MCI Metro have announced plans to enter Ameritech's exchange marketplace in those states. IV. DISCUSSION A. Waiver Standard 18. The Commission may exercise its discretion to waive a rule where there is "good cause" to do so. A waiver of the rules is appropriate if special circumstances warrant a deviation from the general rule and such deviation will serve the public interest. As the Commission recently stated, special circumstances that are unique in degree may justify grant of a waiver if the waiver will serve the public interest. The Commission may take into account considerations of hardship, equity, or more effective implementation of overall policy on an individual basis. Further, grant of a waiver must be based on articulated, reasonable standards that are predictable, workable, and not susceptible to discriminatory application. Therefore, the general test for whether Ameritech may be granted a waiver is whether it has shown special circumstances that warrant deviation from the Commission's rules and that deviation from the rules will serve the public interest. 19. Special Circumstances. We find that Ameritech has shown that special circumstances exist that are sufficient to warrant granting its waiver, subject to the conditions set forth in this Order. Under the Commission's original price cap plan, price cap LECs were subject to a possible sharing obligation, regardless of which X-Factor they used in their annual access filings. Now, however, price cap LECs need not be subject to a possible sharing obligation if they use the 5.3 percent "no- sharing" X-Factor, which is contained in the Commission's recently adopted interim price cap plan. The transition from the initial price cap scheme, under which no "no-sharing" option was available, to the interim price cap plan presents uniquely difficult circumstances for those among the price cap LECs that opt to use the 5.3 percent X-Factor to calculate their PCIs during the 1995 tariff year. Although Ameritech's use of the 5.3 percent X-Factor relieves it of any sharing obligation during the second half of the 1995 calendar year, Ameritech remains subject to a sharing obligation in the first half of the 1995 calendar year when it used a 3.3 percent X-Factor rather than the 5.3 percent X-Factor. Because a LEC's earnings are reported on a calendar year basis, Ameritech's first-half-year sharing obligation will be calculated by averaging its earnings in the second half of 1995 with its earnings in the first half of 1995. Therefore, Ameritech's earnings in the second half of 1995, if they are high, could increase its sharing amount. As a result, Ameritech's potential sharing obligation in the first half of 1995 will dampen its incentives to become more productive during the remainder of the year. We conclude that these special circumstances may warrant deviation from the rules, in the context of the nonrecurrent election that Ameritech wishes to make to have the 5.3 percent X-Factor cover the first half of 1995. We do not find, however, that the competitive conditions that Ameritech claims it expects to experience in its local markets in the future constitute "special" circumstances. 20. The Public Interest. We find that waiving Ameritech's future sharing obligation, based on its actual performance during the first six months of 1995, will serve the public interest, provided ratepayers are not adversely affected. We agree with Ameritech that this relief expedites the Commission's goal of implementing "pure" price cap regulation. Further, grant of the requested relief serves the price cap policy goal of more closely reflecting the incentives of a competitive market. Moreover, grant of this relief would bring about an additional reduction in its 1995 access tariff filing, which several of Ameritech's largest access customers assert they prefer. Accordingly, we conclude that grant of the requested relief would serve the public interest, provided ratepayers are not adversely affected. 21. We have determined, however, that grant of Ameritech's request, as filed, would adversely affect ratepayers. To protect the interests of ratepayers, grant of this waiver should have the same effect on Ameritech's price cap levels as the operation of the sharing mechanism would, if sharing obligations were based on earnings in the first half year of 1995 only. To permit Ameritech's approach of allowing LECs to elect retroactively the 5.3 percent X-Factor in return for the elimination of its potential sharing obligation for 1995 would permit highly profitable LECs to avoid the portion of the sharing obligation that they have incurred as a result of their operations in the first half of 1995. Implementing an immediate rate reduction of a lesser value in lieu of incurring potential sharing obligations associated with the first half of the 1995 calendar year would not be in the public interest. 22. We therefore adopt a "revenue neutrality standard" to evaluate Ameritech's proposal. Under this standard, we will waive Ameritech's 1995 sharing requirements if ratepayers and the public receive benefits that are likely to be equal to or greater than the benefits that they would otherwise receive if the waiver were denied, and if sharing obligations were based on earnings in the first half of the 1995 calendar year only. Thus, granting Ameritech's waiver must bring about additional reductions in its 1995 annual access rates that likely are greater than, or equal to, the value of the sharing and add-back obligations, including interest, that Ameritech would incur in its 1996 annual access tariffs if the waiver were denied and sharing obligations were based on the first half of the 1995 calendar year only. 23. Ameritech proposes in its petition to reduce its PCIs for the 1995 annual access tariff year sufficiently to bring about an additional $26.5 million reduction in revenues. The Bureau has calculated, however, that the value of Ameritech's sharing obligation, including interest, that would be attributable to its performance in the first half of 1995, and thus would be subject to sharing in its 1996 annual access tariffs, will be about $35.071 million. Thus, in order to prevent any adverse impact on ratepayers, Ameritech must reduce its PCIs for the 1995 annual access tariff period to bring about a revenue reduction of $35.071 million, or $8.571 million more than the $26.5 million reduction it has proposed. We therefore are prepared to waive our rule that would require Ameritech to share 1995 calendar year earnings that exceed 12.25 percent provided Ameritech implements this additional revenue reduction. 24. The Bureau estimated the $35.071 million sharing obligation using the following method. First, we estimated Ameritech's annual rate of return for the 1995 calendar year to be 15.15 percent using a trend line regression based on Ameritech's 1990-1994 reported rates of return, which were adjusted for add-back amounts. Pursuant to the Commission's rules, a LEC earning a 15.15 percent rate of return must share 50 percent of its earnings over a 12.25 percent rate of return. Accordingly, we calculated Ameritech's net sharing obligation for the 1995 calendar year by multiplying Ameritech's 1994 average net investment by one-half the difference between the estimated rate of return of 15.15 percent and 12.25 percent. We then divided this amount by two to limit our estimate of Ameritech's sharing obligation to the first half of 1995. We then increased this amount to reflect Ameritech's composite tax rate of 38.1 percent. Finally, we added an interest component to the estimated sharing obligation to recognize the fact that, although Ameritech would incur the projected sharing obligation between January and July, 1995, it is required to discharge the obligation in its 1996 annual access filing. 25. The method we used to estimate Ameritech's sharing obligation for the first half of the 1995 calendar year is a conservative and reasonable approach. Our use of a trend line analysis for estimating Ameritech's 1995 rate of return to be 15.15 percent assumes that the average growth in earnings Ameritech has experienced in the previous four years continued through the first half of 1995. In estimating Ameritech's 1995 rate of return, we relied on long term earnings growth as measured by a trended rate of return (adjusted for add-backs) using historical data through 1994 that Ameritech is required to file with the Commission. We find this approach preferable to making speculative assumptions on how changes in the market place or various corporate strategies might have affected Ameritech's first half 1995 earnings. Earnings data for the first quarter of 1995 are already on file with the Commission. However, we did not rely on the data reported by Ameritech concerning the first quarter of 1995 to determine earnings for the first half of 1995. Because a LEC's reported earnings results for the first quarter of a year are often subject to substantial downward revisions throughout the year, use of first quarter earnings could lead to an overestimate of Ameritech's sharing obligation for the first half of the 1995 calendar year. We believe that a trend of historical earnings produces a more reliable estimate. B. Implementation Issues 26. If Ameritech wishes to waive the requirement in the Commission's rules that require it to share earnings during the first six months of 1995 that exceed 12.25 percent, it must incorporate a $35.071 million revenue reduction in its PCIs using the methodology described in this paragraph. We require Ameritech to treat the reduction as an exogenous cost adjustment, making the necessary Delta Z adjustment to yield a $35.071 million rate reduction over the eleven months of the 1995 annual access tariff period. Thus, to compute the Delta Z, Ameritech should multiply the $35.071 revenue reduction by 12/11, or 1.0909. Moreover, because grant of this waiver, consistent with our revenue neutrality standard, must have the same estimated effect on Ameritech's price cap levels as would the sharing mechanism, we further direct Ameritech to allocate the reduction among all price cap baskets in the same manner that would occur if Ameritech remained subject to the sharing mechanism. Ameritech is also required to reverse this reduction in its 1996 annual access filing using the methodology for reversing sharing that is described in the 1995 TRP. 27. To compute its earnings for 1996, Ameritech should treat the $35.071 million exogenous amount as if it were a sharing amount. Thus, when calculating its 1996 rate of return, Ameritech should "add back" the portion of the exogenous change that it will flow through to its customers in its 1996 annual access rates. If Ameritech does not use the 5.3 percent "no-share" X-Factor in its 1996 annual access tariff filing, it could incur a sharing obligation with respect to its 1996 earnings. This adjustment will prevent an understatement of Ameritech's 1996 earnings that would otherwise be caused by its "sharing" a portion of the $35.071 million in 1996. 28. As to Bell Atlantic's request that the adjustments to Ameritech's indices should be based on six months, not seven, as Ameritech proposes, we note that the Commission already has required an adjustment to account for the one month delay in the effective date of the 1995 annual access tariffs. We have calculated the $35.071 exogenous amount based on a six month period. C. Other Issues 29. After Ameritech filed its petition, three LECs filed petitions similar to Ameritech's requesting that they be permitted to adjust their PCIs for the 1995 tariff year to reflect the effect of a 5.3 percent X-Factor adjustment for the first half of 1995. The petitions were filed by Pacific Bell and Nevada Bell, Rochester Telephone Corp. and Frontier Communications of Iowa, Inc., and Frontier Communications of Minnesota, Inc., and Lincoln Telephone and Telegraph Company. For each of those petitions, we released a public notice establishing a pleading cycle for comments and replies. These three waiver requests will be addressed in a separate order. 30. Sprint filed comments entitled "Sprint Corporation Comments in Support of Ameritech Petition for Clarification or Waiver and Petition for Clarification or Waiver" on May 16, 1995. Sprint's comments regarding Ameritech's waiver petition were included in the record. However, its request that its LECs be granted a similar waiver is unsupported by any showing of good cause for a waiver. If Sprint believes that its circumstances warrant a waiver of the rules, it must file a waiver request not only to make the specific good cause showing required, but also to ensure that interested parties have an opportunity to comment on its request. We therefore dismiss Sprint's request. V. ORDERING CLAUSES 31. ACCORDINGLY, IT IS ORDERED that, pursuant to Section 4(i) of the Communications Act of 1934, as amended, 47 U.S.C.  154(i), and Sections 0.91, 0.291 and 1.3 of the Commission's Rules, 47 C.F.R.  0.91, 0.291 and 1.3, the petition for waiver filed by the Ameritech Operating Companies IS GRANTED subject to the conditions described in this Order and is otherwise denied. 32. IT IS FURTHER ORDERED that the Ameritech Operating Companies MAY FILE revisions to its 1995 annual access tariffs by July 27, 1995 to become effective August 1, 1995, in order to waive their 1995 sharing obligation provided they comply with the requirements in this Order and with the requirements in the Commission's price cap rules. 33. IT IS FURTHER ORDERED that the request for clarification or waiver filed by the Sprint Corporation on May 16, 1995, IS DISMISSED. 34. For purposes of compliance with this Order, we waive the notice requirements of Sections 61.58 and 61.59 of the Commission's Rules, 47 C.F.R.  61.58 and 61.59. The Ameritech Operating Companies should cite the "DA" number of this Order as the authority for this filing. FEDERAL COMMUNICATIONS COMMISSION Kathleen M. H. Wallman Chief, Common Carrier Bureau