Before the

FEDERAL COMMUNICATIONS COMMISSION

Washington, D.C. 20554

In the Matter of

Access Charge Reform

Price Cap Performance Review
for Local Exchange Carriers

Transport Rate Structure and Pricing

Usage of the Public Switched Network
by Information Service and Internet
Access Providers

CC Docket No. 96-262

CC Docket No. 94-1

CC Docket No. 91-213

CC Docket No. 96-263

COMMENTS OF PACIFIC TELESIS GROUP

I. INTRODUCTION

Pacific Telesis Group ("Pacific") hereby submits comments on the Commissions Notice of Proposed Rulemaking ("Notice") which seeks to reform the system of interstate access charges. We agree with the Commissions stated goals for this proceeding: "to ensure that access charge regulations are compatible with the 1996 Act";^{⁽¹⁾ "to eliminate any unnecessary regulatory requirements";^{⁽²⁾ and
"to foster and accelerate the introduction of efficient competition."^{⁽³⁾ The Commission recognizes, too,
that reform of the access charge system to achieve these three goals may lead to revenues that are
"much smaller" than would be required to "permit recovery of the interstate portion of embedded
costs."^⁽⁴⁾}}}

As the Commission is well aware, the existing system of regulating access charges stems in large measure from a one-size-fits-all mentality. The current system imposes a series of government-mandated cost allocation and pricing rules on a state-wide, study area basis which can lead to distortions that adversely affect consumers, competition, and local exchange carriers ("LECs").^{⁽⁵⁾ Some
consumers may pay more than it actually costs to serve them; others pay less. Moreover, when LECs
lower access charges to interexchange carriers ("IXCs") there is no certainty that end users will see
lower prices; historically, the opposite has been true. In addition, competitors are encouraged to make
inefficient investments to compete with LEC access services that are priced artificially high and don't
invest in markets where LEC access prices are set artificially low. Finally, the rules often prevent LECs
from efficiently responding to competition, and inhibit investment in new services.}

The current access charge system is designed to recover all costs allocated to interstate access service, including all current costs. These current costs are allocated between the intrastate and interstate jurisdictions by arbitrary formulae that have one over-riding objective: to keep basic exchange rates low. Interstate costs are recovered by access charges. Access charges also recover some costs of the current Universal Service Fund, which is used to subsidize high cost carriers in rural areas. Likewise, interstate access charges also recover current and embedded LEC costs including investment being depreciated more slowly than economically justified to keep current rates low, as well as the cost of plant that may be stranded due to competition.^{⁽⁶⁾ Plainly, LEC shareowners will be subject to a new,
fundamentally different and greatly increased risk if access reform creates a "regulatory squeeze" by
moving prices to economic costs without providing for the recovery of all current costs outside of the
access charge regime.}

The Notice proposes to reform access charges by several possible means: changing the rate structure; reducing or eliminating regulation to allow market forces to work; and/or continuing to regulate prices but with a changed basis. The ideal thrust of each of these proposals would be, in the Commissions view, to "make [the] system of interstate access charges more economically rational and compatible with competitive local markets."^{⁽⁷⁾ (As discussed in detail below, the likely reality of certain
proposals would be quite the opposite.) To the extent that the Commission's access charge reform
reflects a single-minded principle that prices must be lowered to recover no more than forward looking
costs, the real current costs now included in access charges will be unrecovered and land solely on the
shoulders of LEC shareowners. Under some of the options proposed, LECs would be precluded from
recovering any costs other than forward looking costs in their access charges. Under other options,
certain access charge elements might theoretically include a portion of these costs, but given
competition, cost recovery would be impossible, leaving LEC shareholders "holding the bag."}

Regardless of the nature of the reform, the costs currently recovered by access charges will not go away and may, in fact, increase. The Commission cannot unilaterally remove from a LECs rates the real costs of providing telephone service that have been assigned to the interstate jurisdiction by the separations process. Interstate separations rules can only be changed by a Joint Board proceeding under section 410(c). While the Commission promises timely reexamination of the jurisdictional separations rules,^{⁽⁸⁾ the outcome of any such proceeding is uncertain and in the future. In
the meanwhile, and as required by the Constitution, LECs must be given the opportunity to recover all
costs assigned to the interstate jurisdiction.^⁽⁹⁾}

New universal service policies are subject to an ongoing proceeding.^{⁽¹⁰⁾ To the extent that
universal service costs are now recovered in access charges, some mechanism -- that is sustainable
under competitive conditions -- must be developed to allow LECs to continue to recover the cost of
universal service. Again, a Commission policy precluding recovery of such costs would be
constitutionally infirm.}

While the Notice recognizes that these important issues exist, we are concerned that it does not reflect a commitment by the Commission to allow LECs a means to recover these costs. Rather, the Commission appears to recognize "that implementation of access charge reform is expected to cause a significant reduction in incumbent LEC access revenues from current levels."^{⁽¹¹⁾ However, it
is troubling that instead of tentatively concluding that a means must be found to allow LECs to recover
their costs -- actual costs that have been legitimately incurred -- the Commission merely asks "whether"
such cost recovery should be permitted.^{⁽¹²⁾ Cost recovery not only should be permitted, it is required by
the Act and the Constitution.}}

A true market-based approach represents the best, fairest, and most lawful means of reforming access charges. A market-based approach is fully consistent with the deregulatory, pro-competitive goals of the Act. Properly implemented, it can move the industry towards less regulation and still leave incumbent LECs with the ability to recover current costs. However, certain proposals in the Notice would effectively make regulation of unbundled elements the price for deregulation of access. In particular, the proposed triggers for Phase I relief include: unbundled elements based on the FCC's TELRIC plus a reasonable allocation of common cost; transport and termination charges based on LECs incremental costs found acceptable by the FCC; and wholesale prices based on retail prices minus reasonably avoidable costs also found acceptable by the FCC. These triggers effectively require regulated rates for the unbundled elements in order to receive limited deregulation of some access charges. Moreover, these triggers are both redundant and legally suspect. Redundant, because they repeat requirements already adopted by the Commission in the Local Competition Order.^{⁽¹³⁾ Legally
suspect, because they appear to require an FCC-based pricing standard found legally infirm and stayed
by the 8th Circuit Court of Appeals.}

As we show below, a market-based approach with appropriate triggers should be the outcome of this proceeding. In contrast, the Notices alternative proposal of a prescriptive approach is fraught with legal and practical infirmities. Such an approach moves in the opposite direction from the Acts goal of reducing and eventually eliminating regulation. Instead of promoting competition, it is more likely to remove incentives for market entry by facilities-based competing access providers by artificially driving LEC prices below competitive levels. And, by forcing LECs to price at TELRIC, the prescriptive approach prevents full cost recovery, violating the Fifth Amendment.

We recommend that the Commission adopt a market-based approach as detailed in the Comments of USTA. Phase I relief would be triggered by showing a presence of competition through a state approved interconnection agreement or statement of generally available terms and conditions. Phase I relief would include pricing flexibility, contract carriage and deregulation of new services. Phase II relief--removal of price cap regulation--would be triggered by a demonstration of substantial competition on a service and geographic basis.

We also recommend reform of the current access charge price structure. The Carrier Common Line Charge ("CCLC") should be reduced or eliminated by increasing the Subscriber Line Charge ("SLC") caps or in the alternative by allowing the multi-line SLC to reach its $6.00 cap. Any residual CCLC should be bulk billed based on presubscribed lines. Local switching and tandem switching should include flat-rated port charges, a per message set up charge, and a per minute usage charge. Charges for dedicated facilities for transport should be flat-rated. Portions of the TIC should be reallocated to other appropriate rate elements. The remainder of the TIC should be bulk billed to access customers based on interstate revenues. Finally, when the order in this proceeding is adopted, it should remove the exemption for enhanced service providers.

I. EVEN WIDESCALE DECREASES IN ACCESS PRICES ARE UNLIKELY TO RESULT IN LOWER PRICES TO THE CONSUMER; REDUCTIONS IN ACCESS PRICES SHOULD NOT OCCUR IN ANY STATE UNTIL BOC INTERLATA ENTRY HAS BEEN APPROVED (¶ 41)

The Commissions Notice implies that access prices must fall to more economically efficient rates. Presumably the Commission's goal is to lower prices to consumers. However, there is no evidence that lowering access prices makes consumers better off; that is, that IXCs pass through access charge price reductions to the consumer. With respect to intrastate interLATA services, the IXCs' prices in California have remained essentially stable even though intrastate access charges have been reduced by 63 percent over the past five years (with a 50 percent reduction in 1995 alone) to 1.35 cents per minute on each end. As a result, AT&T's net income in California has more than tripled from $89 million in 1993 to $324 million in 1995. On a rate-of-return basis, the picture is even more stark: from 1990 to 1993, AT&T's rate of return in California ranged from 17 to 26 percent. In 1994, AT&T enjoyed a 43 percent rate of return, and in 1995, following the substantial reduction in Pacific Bell's switched access prices, its rate of return climbed to an astronomical 79 percent. Pacific Bell's 1995 intrastate rate of return, in contrast, was 8 percent. Finally, the "Big 3" IXCs' price-cost margin in California has increased from less than 20 percent just after divestiture to almost 70 percent today. A similar situation prevails in Nevada. Nevada Bell has reduced access charges by 50 percent since 1989, but IXC rates have not reflected this decrease.

Source: California PUC General Order 65A filings

This California experience is a model for how the IXCs behave when access charges fall. Consumers are not made better off; but IXCs rate of return climbs dramatically.

IXC rates of return are not the only thing climbing. Since 1990, the 3 largest IXCs have orchestrated regular price increases, even though their costs of access have fallen. As USTA notes in their comments, access charges have been reduced by about $9B over the past 6 years, while the 3 largest IXCs have all raised their rates, simultaneously six times in the last 5 years. Put simply, IXCs have used lower access fees to fatten their margins, and they have done so with no competitive checks in place to prevent such behavior.

The IXCs have argued that the ever-widening gap between decreasing access charges and increasing long distance prices does not present an accurate picture of the true impact on consumers. This contention is belied by AT&T's own statements, as reported in the New York Times:

The [5.9 percent] increases ... will be felt by a large majority of AT&T's 85 million residential and small business customers, according to Mark Siegl, a spokesman for the company.

The only people not affected are the roughly one million customers who enrolled in AT&T's two-month old One Price calling plan, which offers a uniform price of 15 cents a minute for all long-distance calls within the United States.^⁽¹⁴⁾

Thus, AT&T itself acknowledges that the latest increase will affect all but 1.2 percent of its residential and small business customers, and there is no reason to believe that the impact of past price increases was any less pervasive. Indeed, even the 15 cent per minute price offered by AT&T is far above its marginal costs of providing service. On average, AT&T pays approximately 3 cents per minute for total access charges in California and incurs 1 cent per minute in network costs, leaving roughly 11 cents per minute in profit margin. In Nevada, total access charges are approximately 6 cents per minute, leaving AT&T a profit margin of about 8 cents per minute (better than 50 percent).

The foregoing discussion demonstrates that consumers are paying far more than they should for intrastate and interstate long distance services. The level of interstate access rates is not the reason. Only the RBOCs have the resources and brand recognition to compete with the incumbent IXCs' oligopoly. Pacific and the other RBOCs will enter the interLATA market with zero market share and will have substantial incentives to offer lower prices to attract customers. Consumers will be made better off not by reducing access charges to some artificially low level, but by allowing true competition in all levels of the retail marketplace, including the interLATA market.

Thus, there is one simple rule that must accompany any reduction in access fees paid by IXCs. Before access rates are reduced, the RBOCs must be permitted to enter the interLATA market. The IXCs have already presented evidence why this approach is necessary -- without RBOC entry IXCs will simply pocket the reduced costs and increases prices to consumers with impunity. In addition, it is an approach that can easily be implemented on a state-by-state basis as the RBOC receives authority to offer interLATA service. At the same time, interstate access rates for that state can be reduced consistent with the rules the FCC adopts in this proceeding. In this manner, consumers can be assured that lower rates for IXCs will actually lead to lower rates for end users.

I. ACCESS PRICES BASED ON FORWARD LOOKING COSTS ARE NOT A NECESSARY PRECONDITION TO A COMPETITIVE LONG DISTANCE MARKET; MOREOVER, NO REASON EXISTS WHY ACCESS CHARGES SHOULD NOT APPLY TO UNBUNDLED ELEMENTS (¶¶ 47, 148)

IXCs are trying to cloud the issues surrounding access charges by raising a "problem" that has already been solved. IXCs argue that incumbent LECs and their long distance affiliates will have an artificial advantage in the long distance market if access rates are not brought down to forward looking economic cost levels, and that therefore retail long distance prices will be artificially inflated.^{⁽¹⁵⁾
For essentially the same reason, IXCs argue that access charges should not apply to unbundled
elements. We disagree on both accounts. As Dr. Richard Emmersons declaration attached to these
comments explains in great detail, no price squeeze can occur with the market conditions and rules
already in place.}

The LECs long distance affiliates will be subject to the same access prices as any other long distance competitor. Under imputation rules at both the state level and in section 272 (e)(3) of the Act, the long distance affiliate must either impute the cost of access rates into its pricing of the retail service or buy access service from the BOC on the same terms and conditions as apply to IXCs. In order to engage in a price squeeze, the LEC's affiliate would have to sell long distance below cost, thus losing money with the hope that it can drive the competition from the long distance market. Given the strength of the competitors in the long distance market, and the fact that we will start with zero market share, such an outcome is extremely improbable. Thus, existing rules permit customers to benefit from a vertically integrated firm, while ensuring the firms competitors are not squeezed.

In addition, for a LEC to engage in a successful price squeeze, it must acquire significant market power. "In order to acquire market power over interLATA services, Pacific Bell and other incumbents would have to engage in a financially draining price squeeze and possess the staying power to outlast AT&T, MCI (presumably merged with British Telecom) and Sprint, an unlikely possibility."^{⁽¹⁶⁾
As Dr. Emmerson goes on to explain,}

In any event, bringing switched access charges closer to economic cost would not guard against anticompetitive price squeezes. As the NPRM seems to realize, an anticompetitive price squeeze arises as the result of the relationship between intermediate-good prices and retail prices. The occurrence of a squeeze is not determine by the price of the intermediate good itself.^⁽¹⁷⁾

The IXCs are simply trying to constrain our prices on the intermediate good, while keeping their retail prices unfettered.

For the same reason, it is unnecessary to endorse another IXC position, which is that access charges should not apply to unbundled elements. When unbundled elements are "combined" they mimic the same functions, features and access to the local network that is provided by our access services today. IXCs have asked that access be priced no higher than economic costs, which is lower than the pricing standard applicable to unbundled elements, or, if access charges exceed the prices applicable to unbundled elements, they not apply when unbundled elements are used to originate or terminate an interstate toll call. In either case, IXCs would see lower rates, as compared to todays access charges, for the toll traffic they provide to end users.

However, RBOC affiliates offering interLATA services will see the same rates as IXCs, whether they purchase and combine unbundled elements or buy access services directly from their BOC affiliate. In either case, they will bear the same costs as their IXC competitors for access to the local network, and existing rules again prevent a price squeeze. Thus, as was true with the access charge discussion above, applying access charges to unbundled elements will not lead to a price squeeze favoring BOC interLATA affiliates.

Furthermore, it is important that IXCs and BOC affiliates do, in fact, bear like charges for interstate toll access, both as between themselves and as between services that offer like functions and features. The first proposition is founded in competitive fairness -- there is no reason why IXCs should gain any advantage in access to the local network as compared with BOC interLATA affiliates. The second, however, goes further to make clear that the costs of such access, whether caused by IXC or BOC affiliates accessing the local network, cannot be avoided by these cost causers. Again, the interstate cost of access to the local network is based on a separations process which assigns to the interstate jurisdiction the costs to be borne by interstate toll calling. However, when access charges are reformed, the Commission cannot allow IXCs or their competitors to avoid the recovery mechanism. Thus, when the Commission adopts a new funding mechanism for the current CCLC, TIC, recovery of the depreciation reserve deficiency, and, if applicable, the difference between embedded and forward looking costs of access, such as a bulk billing process, the new mechanism must apply equally to unbundled elements. Access services and unbundled elements offer like access to the local network, and they, therefore, must be priced at like levels to avoid unlawful discrimination.

I. SUBSTANTIAL COMPETITION ALREADY EXISTS IN CALIFORNIA; THE PRESENCE OF COMPETITIVE ALTERNATIVES SHOULD BE THE PREDICATE UPON WHICH MARKET-BASED TRIGGERS ARE BASED (¶¶ 140-155)

"[R]egulation should substitute for market forces only after a clear recognition that market forces are insufficient to produce efficient results and adequately constrain market power."^{⁽¹⁸⁾
The FCC needs to recognize that competition in California is already very robust both in the access
market and the local market. As such we may be in a very different situation than other LECs whose
markets have not been opened. Schmalensee & Taylor recognize that}

It is important to note that rules for reducing regulatory constraints be based on actual state experience as opposed to artificial criteria established by the Commission that may not be approved in the states. Basing rules on the latter possibility fail to take into account real market dynamics and penalize ILECs by maintaining unneeded regulatory constraints."^⁽¹⁹⁾

Competition in the access market has recently expanded from the dense urban areas to the second-tier markets. In dense metropolitan areas such as San Francisco and Los Angeles, there are 6 different competitive fiber based networks in each area competing with Pacific Bell for the most attractive business customers. In addition, Competitive Access Providers ("CAPs") have also leased space on utility rights-of-way to further expand their networks. There has been significant expansion of competing fiber networks in the past year. More than 2/3 of wire centers with collocation cages are outside of the 4 major metropolitan areas in California.

Statewide, 206 collocation cages have been built in 79 wire centers by 14 different CAPs. These offices contain the vast majority of Pacific Bells traffic, indeed, almost 90% of Pacific Bells switched and special access traffic. Last year the number of cross-connects terminating in those cages tripled to 20,700 DS1 equivalents. These connections have the capacity to carry about 75% of Pacific Bells switched access traffic. With a large number of competitors in each area, it is not surprising that there are 6 to 9 collocation cages in each of our most attractive serving wire centers. The next page shows a map of California detailing the depth and breadth of competition in the state.

Access competition is intense in specific geographic markets. Over 90% of Pacific Bells DS1 & DS3 traffic exists in those offices with collocation, cross-connects, and competitive fiber networks. In San Francisco and Los Angeles our market share for special access Hicap has plummeted to 54%.^{⁽²⁰⁾ On our competitors' special access Hicap facilities, it is estimated that over 78% of the traffic
on DS1s and over 52% of DS3 traffic is switched access traffic.^{⁽²¹⁾ This is not surprising since the nearly
1,500 IXC California Point of Presence switches can switch all types of traffic. In many cases DS1s and
DS3s provide attractive alternatives to switched access. ^⁽²²⁾}}

The local market provides another snapshot of the burgeoning California telecommunications market. Sixty-nine Competitive Local Exchange Carriers ("CLCs") have been approved to provide local service in California. Twenty-two additional companies are awaiting approval. Of these 91 competitive local exchange companies, 48 are facility based. These companies have opened 548 NXX codes which equate to 5.5 million new telephone numbers. Indeed, the demand is so high that the CPUC is now rationing NXX codes in many areas.^{⁽²³⁾ These codes cover over 90% of
Pacific Bells total business and residential lines.}

There are 35 new competitive local switches in California with numerous additional installations planned for 1997. As noted above, a vast majority of the long distance carriers 1,500 switches can readily be upgraded to carry local traffic via software modifications. Seven different CLCs installed 17,166 local interconnection trunks in 1996. One hundred and one million minutes of use were terminated by Pacific Bell on CLC networks just during the month of December; billions of minutes will be exchanged in 1997. "With its rich market and salutary regulatory climate, California has become the primary target of AT&T's expansion plans."^⁽²⁴⁾

These conditions belie any notion of "competition in its infancy" insofar as concerns California. More importantly, they show a strong presence of supply alternatives to our services. Switched access services are being provided by CLCs (formerly "CAPs") today through their extensive fiber ring networks and the collocation cages they have placed throughout California. In many cases, major IXCs have moved traffic off our local transport network and onto the networks of CLCs to enjoy reduced access charges for the origination and termination of toll traffic. In addition, these same competitors provide their own loops directly to end users, and can capture not only the end users traffic but all access charges associated with the loops they provide.

There is only one predicate necessary for these competitors to offer substantial alternatives to our services -- the ability to interconnect with our network. Once that is in place through a state commission approved interconnection agreement, a viable alternative to our access service exists. An approved interconnection agreement should become the 'trigger" for adoption of a market-based approach to access pricing. Nothing further is or should be required. Moreover, the substantial competition we face in California is compelling evidence that market forces are already serving as a viable check on our access prices.

I. THE COMPETITIVE FACTORS THE COMMISSION PROPOSES TO USE TO DETERMINE THE PRESENCE OF SUBSTANTIAL COMPETITION ARE NOT ECONOMICALLY RATIONAL. (¶¶ 156-160, 203-210)

The Commission addresses proposed competitive factors in two different parts of the Notice. In its initial discussion, it seeks comment generally on demand responsiveness, supply responsiveness, market share, pricing of services under price caps, and other factors to be considered in assessing the competitiveness of the market.^{⁽²⁵⁾ Yet, in the discussion of market-based access reform,
particularly with respect to Phase II, it discusses only one of these, market share, as an indicator of
competition.^⁽²⁶⁾}

While market share, along with demand and supply elasticities may be appropriate indicia in antitrust cases, "market share is not only an insufficient indicator of competition, but in regulated industries, it is also irrelevant."^{⁽²⁷⁾ Regulation serves to sever market power from market share. Thus
"only the appearance and not the reality of monopoly power is created thereby."^⁽²⁸⁾}

No reliable LEC data exists to measure market share. Our own data will be of little or no use to the Commission in determining how much market power we have; our competitors data is needed. What we have on our competitors is the proverbial tip of the iceberg -- the rest is proprietary. The Commission could order our competitors to supply data, such as maps of their principal transmission lines and switching capacity,^{⁽²⁹⁾ but our competitors would likely seek confidential treatment
of this data, and a FOIA proceeding would have to be concluded before anything could be done with it.}

Because user demands are so highly concentrated in telecommunications services, even knowing the full extent of our competitors networks would not indicate the true degree of competitive pressure on our services. One of the most important forms of competition is self-supply or contract carriage by large, intensive users, providing direct connections to IXCs using satellite, optical fiber, or microwave, and self-supplying their own services. Competitors abound; competitive factors to be examined must recognize them.

I. THE COMMISSION SHOULD ENCOURAGE A MARKET-BASED APPROACH TO ACCESS PRICING WHICH BENEFITS CONSUMERS AND ADVANCES COMPETITION; IT WILL NOT GET THESE RESULTS WITH RESTRICTIVE TRIGGERS OR A MAZE OF COMPLEX PRICE CAP RULES WHICH BLOCK OR FRUSTRATE LEC PRICING FLEXIBILITY; MOREOVER, CREATING ARTIFICIAL PRICING DISTINCTIONS FOR LIKE SERVICES (UNBUNDLED ELEMENTS AND ACCESS CHARGES) WILL KILL OFF INVESTMENT VITALLY NEEDED TO ACCOMPLISH FUNDAMENTAL ACT OBJECTIVES (¶¶ 161-217)

A. Summary of Pacifics Proposal for Market-Based Triggers, Price Cap Reform, and the Pricing of Access Charges and Unbundled Elements.

There are three major components to our proposal for access pricing founded on market forces: 1) identifying the appropriate triggers, 2) defining what pricing freedoms should be permitted, and 3) setting the correct relationship between unbundled elements--particularly combined elements that are the functional equivalent of switched access---and access charges. Underlying our proposal are three critical objectives, or tests, that have to be passed for the plan to succeed. First, there has to be sufficient competition to keep access prices at market levels; second, the LECs and their shareowners must be accorded a reasonable opportunity to recover all the costs of telephony; and third, the plan has to encourage investment.

Our proposal begins with a single, realistic trigger -- a demonstration that entry barriers have been eliminated and therefore nothing stands in the way of other facilities-based providers from supplying access services. It is, we concede, a trigger founded on supply elasticity, and one which will (correctly) side-step endless wrangling over market share or demand elasticities. Moreover, this trigger is met when the LECs state commission has ended all legal barriers to entry and the LEC has entered into interconnection agreements which have been approved by state commissions. When no legal barriers prevent entry, when competitors have actually entered the market, and when traffic is being passed, the ability to increase price above competitive levels has ended.

There is no reason to micro-manage access prices when alternative suppliers are present, but pricing freedom means nothing if its execution is tied to a maze of regulations few, if any, can claim to know or have mastered. The current price-cap structure is a bureaucrats labyrinth, but it offers no hope of competitive prices reflecting both costs and market conditions. The current structure has to be simplified to allow contract carriage, volume discounts, and reduced number of baskets and bands, and geographically deaveraged prices.

Finally, the FCC should resist all temptations to manipulate the access market by creating an artificial and mandated price differential between unbundled elements and access charges. The Notice suggests such a differential could serve as a competitive check on access price increases. It is doubtful, however, whether this purpose would ever be served by such a pricing differential, and it would create other problems. In addition, with the competition we face, it is entirely unnecessary. More importantly, micro-managing the prices of unbundled elements and access charges will undermine the LECs ability to recover its costs while at the same time discourage the very investment necessary for a healthy telecommunication infrastructure and the development of competitive, alternative providers. When unbundled elements are used to originate or terminate interstate calling, interstate access charges must apply to unbundled elements to prevent destructive arbitrage. Moreover, the application of state access charges must remain within the province of state commissions.

A. Phase I Should Be Triggered By An Approved Interconnection Agreement Or Statement Of Generally Available Terms and Conditions. (¶¶ 168-179)

The Act imposes various duties on LECs. These duties include the section 251 requirements (unbundling, interconnection, number portability, etc.), accounting safeguards, and structural safeguards.^{⁽³⁰⁾ Thus, there already exists a system of Congressionally-imposed checks and
balances to ensure that the local and access markets embrace competition.}

The key to securing effective competition in access services is overcoming the entry-deterring effect of the substantial sunk cost associated with local exchange facilities. Consequently, the attachment of open access to local networks constitutes the relevant test of competitiveness.^⁽³¹⁾

The Commissions effort to insert additional and repetitive checks through the triggering process is unnecessary, unwarranted and does not support a deregulatory framework.

Unbundled loops, switching and transport give entrants easy access to existing customers. Collocation, resale and other obligations also promote entry. "In combination, the Act's open access provisions have significantly reduced or eliminated entry barriers associated with heavy sunk costs."^{⁽³²⁾ There are few if any places where that is more true than in California where entrenched
competitors are wresting customers from us on a daily basis. Therefore, the appropriate trigger for
Phase I flexibility should be the removal of entry barriers as indicated by an approved interconnection
agreement or statement of generally available terms and conditions. Pacific Bell has 18 interconnection
agreements with 14 carriers (including 3 CPUC-approved arbitrated agreements with AT&T, MCI, and
Sprint).}

A separate proceeding should not be necessary to establish that Phase I or Phase II triggers have been met. Instead the Commission should simply require a LEC to show the presence of competition through a state approved interconnection agreement, or through a state approved statement of generally available terms and conditions. That could be accomplished by incorporating the showing into the Description and Justification section of a tariff filing. Parties wishing to object to the tariff on the basis that a trigger has not been met could do so by way of the current process of petitioning to suspend or reject the tariff. Requiring a separate proceeding, as proposed in the Notice^{⁽³³⁾ will simply
pave the way for competitors to further delay deployment of beneficial terms, and will increase
administrative complexity associated with instituting appropriate reforms.}

A. Phase I Relief Permits Pricing Flexibility (¶¶ 168-200)

Once the Phase I trigger has been met for the study area, a carrier will be eligible for the simplified price cap basket structure explained in detail by USTA in its comments,^{⁽³⁴⁾ volume and
term discounts, contract carriage, and elimination of onerous Part 69 requirements. We agree with
USTA that each of these areas is important and will substantially increase access pricing efficiency.}

1. Contract Carriage Would Substantially Benefit Customers In Many Access Markets (¶¶ 193-196)

One element of Phase I relief is contract carriage. The Commission proposes that the contract tariff would be required to be made publicly available through a tariff filing setting the contracts terms, and making it generally available on same terms and conditions to similarly-situated customers. Once a service is subject to contract carriage, the Commission proposes to remove it from price caps. We strongly support this approach to contract carriage.

Some have criticized contract carriage because they fear that, under the filed rate doctrine, a carrier would have the ability to modify a tariff unilaterally, even over a customer's objection.^{⁽³⁵⁾ The filed rate doctrine holds that in cases where both a contract and a tariff govern a
carrier's provision of services to a customer, in the event of a conflict between the two, the tariff
controls.^{⁽³⁶⁾ Some fear that this doctrine, coupled with Section 203 of the Act, permits a carrier to
modify the terms of a contract through a unilateral tariff filing.}}

A close reading of the law indicates that these fears are unfounded. Well-established tariff law severely constrains the ability of a carrier to modify a tariff over the objections of a customer. Since the 1970s, the Commission has recognized that customers entering into long-term service relationships with a carrier are entitled to the benefits of that relationship, absent special circumstances. Thus, tariff revisions that alter material terms and conditions of a long-term contract will be upheld only if the carrier can demonstrate "substantial cause for change."^{⁽³⁷⁾ The "substantial
cause" doctrine was imported into the contract carriage arena in the Interexchange Order}.^{⁽³⁸⁾ There,
the Commission emphasized the fact that tariff provisions were the result of individual negotiation; thus,
if a carrier were permitted to alter a contract unilaterally, the benefits of that negotiated agreement
would be diminished.^{⁽³⁹⁾ The Commission also stressed that, given the substantial competition in the
business services market, it was unlikely AT&T would attempt to modify established tariff provisions.^{⁽⁴⁰⁾
All of these principles are grounded in the prohibition of unreasonable practices by carriers in Section
201(b) of the Act.^⁽⁴¹⁾}}}

California has permitted intrastate services to be provided under filed contracts since 1987. Partially competitive and fully competitive services may be offered on terms and conditions different from those in the general tariff for the service. The contracts filed with CPUC disclose the terms of the agreement (prices, service description, volume limitations and term). Commercially sensitive information, including the customers name, may be kept confidential. The CPUC has recognized that the marketplace and consumers are better off if LECs have contracting flexibility in competitive areas. ^⁽⁴²⁾

We agree with the Commission that for Phase I relief, there will need to be a one-time adjustment of our price cap or service band indices to reflect the reduction in revenues when a contract takes effect. We suggest that in the annual filing, a rate element line be added to each service band affected by contracts that took effect during the base demand period. This line will contain the aggregate price reductions in that service band as a result of any contracts. Because of the requirements of the price cap model, the current price will be the aggregate revenues before contracts, and the proposed price will be the aggregate revenues after contracts with a base period demand of one. The base period demand for the rate elements affected by contracts will also be reduced to reflect only the quantity being offered at the tariffed rate and to avoid double-counting the revenues received from those rate elements. Subsequent reductions in contract prices, a likely effect of increased competition, will therefore not result in any increase in "headroom" (i.e., additional upward pricing flexibility) for the affected basket or bands. Under this proposal, we would have no more ability to increase price capped rates than the current rules afford us.

1. New Services Should Not Be Subject To Onerous Requirements Such As Part 69 Waivers Or Public Interest Tests (¶¶197-200)

The Third Report and Order, issued concurrently with the Notice, purportedly "eliminates the need for obtaining a waiver before an incumbent LEC introduces a new service."^{⁽⁴³⁾ In
reality, though, the Commission simply substitutes one onerous process for another. In the Third
Report and Order, the Commission requires that a party seeking to introduce a new service show that
the new service is in the public interest. However, in the Notice, the Commission asks whether it
"should eliminate all requirements that an incumbent LEC obtain any regulatory approval before a tariff
introducing a new service can take effect.^{⁽⁴⁴⁾ New services, which offer customers new options and
features, should be allowed to go into effect without any regulatory process proving that it is in the
public interest, or meets any artificial Part 69 definitions. This has always been the case with special
access services. As a result, special access services became the first highly competitive service in LEC
territories. If the Commission is committed to a deregulatory market, then the market will determine
whether a new service is in the public interest. If it is, customers will buy it; if not, it will not generate
any revenue.}}

The Commissions mandate in the Communications Act is to encourage the introduction of new service and technologies:

It shall be the policy of the United States to encourage the provisions of new technologies and services to the public. An person or party (other than the Commission) who opposes a new technology or service proposed to be permitted under this Act shall have the burden to demonstrate that such proposal in inconsistent with the public interest.^⁽⁴⁵⁾

Contrary to its mandate, continued use of the Part 69 waiver process, or a process that requires new services to be found to be in the public interest, has the effect of discouraging innovation and introduction of new services. Continued regulatory oversight over new services is unnecessary. The Commission should not regulate them prior to introduction, via required waivers or petitions, but also should not subject them to price caps.

We expect most new offerings to be the result of incremental improvements in network functionality. Because we do not manufacture telecommunications equipment, we rarely have access to technology or know-how that is not already on the market. SONET, fast packet switching services (frame relay and SMDS), and ATM switching, for example, are based on new switch functionalities developed by switch manufacturers (e.g., Lucent, Newbridge, and Cisco). For this reason, any theoretical advantage we might have over our competitors is short-lived. By the time a new service is allowed and a tariff has taken effect, we are rarely the first or only provider; usually, a multitude of service providers offer fully competitive products. These competitors products usually compete with our existing product line, so lengthy reviews of new service offerings designed to meet competition allow competitors to win our customers. The continued use of Part 69 to mandate rate structures constrains our ability to meet competition and to deploy new services. Therefore, Part 69 should not be applied to new services.

1. Geographic Deaveraging Must Be Authorized To Reflect Variations In Costs (¶¶ 180-186)

Our costs vary geographically. In the federal and state universal service proceedings, and in our arbitration filings at the CPUC, we have submitted data supporting these cost differences. As a result, the CPUC has approved unbundled transport and switching element prices which vary by geography across 4 zones. Similar geographic deaveraging is necessary for access prices because, as the Commission recognizes, "[w]here unbundled network elements are deaveraged, continuing to require access rates to be averaged across the study area would foreclose the incumbent LEC from meeting competition from unbundled network elements in low-cost areas, while still requiring the incumbent LEC to charge below-cost access rates in high cost areas."^{⁽⁴⁶⁾ In the Local Competition
proceeding, the Commission concluded that "deaveraged rates more closely reflect the actual costs of
providing interconnection and unbundled elements."^{⁽⁴⁷⁾ Because the zones that have been established by
the CPUC for unbundled elements are cost-based, the same zones should be used for access pricing. In
that way, zoned pricing will reflect consistency between services that are functionally equivalent.}}

1. Term And Volume Discounts (¶¶ 187-192)

As the Commission has proposed, we support term and volume discounts for all access services. Term and volume discounts promote competition and foster pricing efficiency. The marketplace demands them. Our competitors use them liberally. They are an essential means to drive prices towards economic costs and to keep customers on our network. Term and volume discounts should be nondiscriminatory, and offered to all similarly situated customers. No special showing or cost justification should be required once the Phase I trigger has been met. Antitrust guidelines offer appropriate economic price floors; no additional Commission oversight is necessary.

A. Phase II Should Remove Services From Price Cap Regulation When Competition Is Demonstrated In The Area (¶¶ 201-217)

1. Substantial Competition Should Be Established By Service And On a Geographic Basis. (¶¶ 202-210)

Once CLCs are using the interconnection arrangements negotiated with the ILEC, and unbundled elements or other services have been purchased, and minutes are being exchanged, the ILEC services that compete with the CLC services should be freed from price cap regulation. Because competition for services varies, not only in different parts of the country, but also within a single study area, the competitive showing in Phase II should be on a geographic basis using a wire center or a group of contiguous wire centers. As we explained earlier in Section IV, competition is extremely concentrated. Competitors can serve relatively limited areas and take a substantial amount of our business. We need to be able to meet this competition in these areas. Examining wire centers will provide an appropriate picture of the state of competition in that particular area. For each geographic area, a company will be able to make its competitive showing on the basis of a single service, or group of cross elastic services.

We believe that a competitive showing should be based on availability of alternate providers. The type of information we would provide is as follows:

Summary of Access Competition

Geographic
Area
Number of Competitive Fiber Networks Number of Collocation Cages Number of Cross-Connects

Wirecenter₍₁₎

Wirecenter₍₂₎

Wirecenter_(n)

In addition, we could also supply a status of local competition in the area:

Status of Local Competition

Services Offered By CLCs

Geographic
Area
Local Inter- connection Trunks Local Usage Exchanged
(MOU per mo.)
Number of NXX Codes Opened by CLCs CLC local switching
(Y/N)
Resale lines in service
(Y/N)
Unbundled loops in service
(Y/N)

Wirecenter₍₁₎

Wirecenter₍₂₎

Wirecenter_(n)

A. The Commission Should Forbear From Regulating DS1 And Higher Special Access Services Since They Face Substantial Competition (¶ 153)

Forbearance is mandatory when regulation is no longer necessary to ensure just and reasonable rates, when regulation is no longer needed to protect consumers, and when forbearance is in the public interest.^{⁽⁴⁸⁾ Special Access and Collocated Direct Trunked Transport (DTT) meet these
requirements, as do interexchange and directory assistance, as explained in the USTA comments.}

As USTA cites in its Comments, Pacific Bells market share of provisioned special access service has been reduced to 54.6% in Los Angeles and 53.1% in San Francisco as of the end of the Third Quarter 1996 (Report prepared by Quality Strategies, Washington D.C.). The loss of nearly half the market share in these areas is a clear indication of the competition in this market. Furthermore, in the Quality Strategies Study, we learned that 79.1% of the traffic on DS1 service is switched access traffic. For DS3 service, 56.0% of the traffic is switched access. The results here specifically prove that special access facilities, which are highly cross-elastic for switched traffic, are subject to significant competition; customers are being served very well by the competitive market and there is no need to continue to regulate these services.

As USTA has correctly pointed out, the ILECs should be afforded the opportunity to respond to competition when market conditions exist for several types of services which are now and have been subject to intense competition as described above.

I. THE FCC SHOULD NOT ADOPT THE PRESCRIPTIVE APPROACH TO ACCESS PRICING (¶¶218-240)

As explained above, the Commission can attain its goal "to foster the development of substantial competition for interstate access services" through a properly implemented market-based approach to access reform.^{⁽⁴⁹⁾ For all of the reasons previously discussed, the access reform policies
advocated by Pacific will both realize all of the advantages of a market-based approach identified by the
Commission as well as address the putative "disadvantages" about which the FCC noted some
concern.^{⁽⁵⁰⁾ Pacifics approach will, thereby, obviate any need to combine a market-based approach with
elements of a prescriptive approach and, as a result, avoid embroiling the Commission in burdensome
regulatory processes that can never hope to replicate the efficiency-enhancing capabilities of
marketplace forces.}}

The Notice seeks comment on the feasibility of adjusting price cap indices downward, or represcribing access rates, to reflect the difference between current rate levels and those which would obtain under a forwarding looking cost methodology such as TSLRIC or TELRIC. The FCC tentatively concludes that some form of such a costing methodology should be employed, and asks parties to address how it might be implemented by the Commission or the states.^{⁽⁵¹⁾ It also invites
comment on a number of alternative adjustments to the price cap rules that could achieve the same
end.^⁽⁵²⁾}

The FCC admits that the prescriptive approach to access reform is being advocated principally by IXCs, which are the entities that stand to benefit the most from a flash cut reduction in their access costs and the shifting of those costs to other entities, i.e., the ILECs and the public. Historically, of course, such access charge reductions have not been passed through to end users. Like their advocacy of the confiscatory Hatfield Model, the IXCs purposes here are transparently obvious and legally suspect, as noted by the Eighth Circuit.^{⁽⁵³⁾ The Commission should not be seduced into
following their lead.}

In fact, even apart from the availability of the far better alternative of a market-based approach to access reform, the prescriptive approach to access reform is antithetical to competition, unreasonably burdensome, and will fail to meet the stated goal of efficient pricing. In particular, it will not lead to rational pricing of toll services or meet any other goals of the Act. Rather, IXCs will merely take advantage of the process to pad their already exorbitant toll margins, just as they have in the past.

Moreover, the prescriptive approach discussed by the Commission simply cannot be implemented as either a legal or practical matter. First, a regulatory prescription to reduce access rates to TSLRIC or TELRIC--without establishment of a mechanism to guarantee recovery of ILECs actual embedded costs--cannot lawfully be adopted absent: (1) separations reform, which the Commission has deferred to a later date,^{⁽⁵⁴⁾ and (2) universal service reform to ensure recovery of mandatory
subsidies, which remains pending and requires substantial changes from the Joint Boards
recommendations in order to satisfy legal requirements,^{⁽⁵⁵⁾ in order not to run afoul of takings
prohibitions. Second, the task of prescribing the level of each access charge element and subelement is
one which the Commission has repeatedly declined to undertake in its price cap proceedings,^{⁽⁵⁶⁾ runs
counter to the general deregulatory goals of the Act, and would undermine all efficiency incentives
inherent in the price cap regime. Accordingly, as set out in detail below, the Commission should reject
all elements of a prescriptive approach to access charge reform.}}}

A. The FCC May Not Lawfully Implement The Prescriptive Approach To Access Reform Described In The Notice (¶¶218-240)

Common to all of the prescriptive proposals raised in the Notice is a Commission-mandated reduction in current access rates quantified on the basis of forward-looking cost principles. This would be the case whether the FCC prescribes new rates itself, directs state commissions to complete the necessary cost studies and prescribe new rates, or reinitializes price cap indices in order to require its desired rate reductions. Nor can the Commission rely on cost proxy models, such as the Hatfield model, to establish access rates. Whatever the merits of individual models for disaggregating loop costs to small units of geography in connection with universal service subsidies, they have no place in setting access prices, because they deemphasize the influence of usage, are based on theoretical cost of idealized networks, not the carriers actual technology choices and facility mix and, in particular, ignore many prudently incurred costs.^{⁽⁵⁷⁾ Each of these alternatives suffers from the same fatal defects
and should be rejected.}

1. Access Charges May Not Be Reduced Prior To Separations Reform (¶¶218-240)

In the Notice the Commission defers separations reform to a future proceeding.^{⁽⁵⁸⁾ The
existing Part 36 separations rules provide, in relevant part, for the allocation of carriers actual fully
distributed costs to the interstate jurisdiction on the basis of direct assignment, where possible, relative
use, or a 25% allocator.^{⁽⁵⁹⁾ Nothing the Commission does in this proceeding can change those rules.^{⁽⁶⁰⁾
Rather, pursuant to Section 410 of the Communications Act, 47 U.S.C. §410, a Joint Board must be
convened to effect a change in the separations rules. Thus, the amount of costs to be recovered under
the access charge regime cannot be reduced in this proceeding.}}}

It is also well established that carriers must be permitted to recover their costs of operation.^{⁽⁶¹⁾ This would include recovery from the interstate jurisdiction of all costs allocated to that
jurisdiction by the separations process. It follows that the FCC lacks the power to prohibit the recovery
of the full interstate allocation of separated costs by prescribing access rates--or reinitializing price cap
indices--based on some other measure of cost not consistent with the separations rules.^{⁽⁶²⁾ Further,
because the Part 36 rules, including the definition of costs, may not be modified except by a Joint Board
convened pursuant to Section 410 of the Act, the Commission may not in this proceeding prescribe a
different measure of cost for the calculation of access rates. Accordingly, if interstate access rates are
reduced, the Commission must assure some alternative means of recovery.}}

1. Proxy Models Should Not Be Used For Pricing

Proxy models should not be used for pricing access services or unbundled elements. In the universal service docket, we have advocated use of a proxy model in order to disaggregate loop costs down to very specific geographic areas in order to estimate costs of service. No cost studies exist with the granularity necessary to estimate wide variations in loop prices across geographies. Thus proxy models provide an essential component for determining proper subsidy distribution. "When estimating costs for pricing purposes, the economically preferred method is to reflect as closely as possible the actual choices faced by engineers in placing relevant facilities."^{⁽⁶³⁾ Detailed cost studies,
specific to each LEC, must be the basis of pricing decisions, not a model designed to broadly estimate
costs of serving particular geographies.}

For the following four reasons, proxy models should not be used to price access services or unbundled elements. First, cost studies are being performed all over the country to determine the cost of unbundled network elements and access. The California PUC has completed a TSLRIC cost study of Pacifics services, and is currently evaluating additional cost studies. Second, there is no reason for the same level of geographic deaveraging of access that is required for universal service. Proposed access charge deaveraging is into a handful of zones. Proposed universal service deaveraging is down to a Census Block Group. Third, the currently existing models do not have the data inputs necessary to determine the cost of access with any degree of accuracy. And, fourth, models--which are at best estimates of costs--should not be used to determine the total amount of compensation that is available to a LEC for the provision of its service.

a) Cost Studies Are Already Available To Price Access

Models should not be used as a substitute for individual company geographic specific cost studies. Cost studies are available. The cost studies reviewed by the CPUC utilize company-specific facilities information and actual usage information--holding times, distances, routes--that is not available as inputs to any of the models that have been proposed for universal service cost calculation and for which there is no reasonable surrogate.

a) There Is No Need To Disaggregate Access Prices To Small Geographic Units

There is no regulatory need for the small geographic definition of costs in access reform. The proxy models were originally developed to create a high degree of geographic deaveraging. The cost of residential basic exchange service varies enormously from geography to geography.^{⁽⁶⁴⁾ Pacific
has found, for example, that the costs within a single wire center (Chico, California) vary from a low of
$24 to a high of $128 per customer per month. Actual cost information at that level of detail is not
available. Models were proposed to estimate the cost variations that occur among high cost areas in
order to avoid awarding too great a subsidy in one area and too little subsidy in another area. No one
has proposed pricing access by these small geographic units. The smallest geographic units currently
proposed are a handful of zones. Even if pricing for usage is driven down to the wire center, cost
studies are adequate to price access}

a) The Existing Models Do Not Contain Adequate Data for Access Pricing

The data inputs of the models do not accurately determine the cost of access and a large number of the unbundled network elements. The proxy models contain vast amounts of geographic data. The costs of providing basic residential service vary in a manner reasonably related to the density, distance, terrain and other characteristics from which relationships can be drawn, data can be assembled and predictions can be made. This is not the case for access services. While estimates of the cost of residential basic exchange service depend upon the geographic distribution of customers, access services vary in cost according to the volume of traffic associated with the facilities. While the cost of the facilities may be predicted by looking at geographic data, the degree of sharing of the facility with other access services can only be arrived at through guesses. The cost of a minute of access or transport depends critically on the aggregation of traffic that is sent over that terrain. There are significant economies of scale in providing access, which is largely assumed to be a declining cost market. Under those conditions, the volume data that cannot even be reasonably approximated by a model, but can be accurately measured for a cost study, is absolutely critical. The "dependency on the volume of usage is so strong that it overwhelms the effect of geographic influences."^⁽⁶⁵⁾

One must know how many minutes are sent over a facility before any reasonable estimate of the cost per unit can be attempted. This data is not contained in any of the models, nor are reasonable surrogates. In residential basic exchange services, for example, one can (and the models do) assume that if a count of households in a geographic area can be obtained, then the number of residential lines can be estimated. Even in a forward looking cost study, the amount of current traffic is the best indeed the only reliable estimate of future traffic. None of the models currently proposed have a source for the estimate of traffic.

a) Models Should Only Be Used To Estimate A Subsidy, Not Total Compensation

Model estimates should not be used in lieu of actual costs for the total compensation available to a company for the provision of a service. In the case of universal service, the Joint Board is not calculating the total compensation that will be available to a LEC (CLEC or ILEC) for the provision of universal service. Rather, the Joint Board is determining the appropriate subsidy that should be made available--really the amount of subsidy that one customer should pay to the benefit of another.^{⁽⁶⁶⁾ The
total compensation for ILECs and CLECs alike will be the sum of the subsidy that the Joint Board
determines is appropriate plus the price of basic service. Moreover, the estimates of universal service
are independent of the company serving the area.^⁽⁶⁷⁾}

If the subsidy is inadequate in an area, the ILEC or CLEC may seek an increase. The case for access pricing is quite different. In using proxy costs to set prices, the FCC would be determining the total compensation available to an ILEC for the provision of access services. That compensation should not be made on the basis of a model estimate when complete, area-specific, company-specific, facility-specific cost studies are already available. Models, by definition, only produce estimates of costs. These estimates reflect averages of numerous inputs over the entire country. For compensation purposes, it is legally incorrect to restrict the total compensation for a service to an estimate that may or may not cover actual cost of providing that service.

Beyond the proxy models ability to accurately predict access prices are the incentives to understate costs by the sponsor of the Hatfield model. AT&T and MCI well understand that any errors in setting prices inherently favor entrants over incumbents. Incumbents must continue to provide access to all geographic areas. Entrants can choose where they are financially advantaged to build and where they should buy facilities. If a model creates distortions in the price/cost relationship, entrants are poised to take full advantage of the model errors. They can choose to build in areas (or for customers) where application of the model produces prices that are too high relative to cost and choose to buy in areas (or for customers) where application of the model produces prices that are too low relative to cost. The fact that they can choose on a customer-by-customer basis to buy the facilities on a resale basis or an unbundled/rebundled basis makes that fact an even richer source of financial opportunity for entrants. Since every error in the price/cost relationship favors the entrant, it is easy to see why AT&T and MCI are so willing to use models in lieu of more accurate costs to set prices.

1. Use Of TSLRIC To Reprice Access Services, Reinitialize Price Cap Indices, Or Justify Above-Cap Filings Would Effect Unconstitutional Takings (¶¶223-238)

As demonstrated in the Local Competition Proceeding and recognized by the Eighth Circuit, pricing ILEC services and facilities at TSLRIC or even the FCCs version of TELRIC will fail to compensate ILECs adequately for those resources.^{⁽⁶⁸⁾ Indeed, by basing its costing methodologies on
a hypothetical network utilizing the most efficient technologies, the FCC would ensure that incumbents
will never be able to recover their actual operating costs. This would be true both with respect to
reinitializing price cap indices on that basis as well as evaluating filings for above cap relief by that
standard.}

Yet, it is well settled that, consistent with the Fifth Amendments prohibition against uncompensated takings, a utility must be permitted revenue recovery sufficient to "maintain its financial integrity, to attract capital, and to compensate its investors for the risk [they have] assumed."^{⁽⁶⁹⁾ In order
for rates not to be deemed confiscatory, there must be "enough revenue not only for operating
expenses, but also for . . . capital costs," which "includes service on the debt and dividends on the
stock."^{⁽⁷⁰⁾ Plainly, there can be no such sufficient return, and rates would necessarily be deemed
confiscatory, where a company is prohibited from recovering even its actual capital expenditures. But,
that would be the case under any limitation of access recovery to TSLRIC- or TELRIC-defined costs.^⁽⁷¹⁾}}

A. Practical Implementation Difficulties Will Doom Any Prescriptive Approach (¶¶218-240)

From the very beginning of its price cap proceedings, the Commission was urged to establish the price cap indices on the basis of detailed cost studies in order to prescribe assertedly appropriate initial price levels for individual rate elements.^{⁽⁷²⁾ However, numerous carriers, including
AT&T, properly pointed out the tremendous practical problems that would be encountered in
attempting to engage in such a comprehensive reevaluation of rate levels as well as the enormous
burden on regulatory resources that it would occasion.^{⁽⁷³⁾ Moreover, it was evident that whatever
benefits might be sought under such an approach could much more readily be secured under a properly
structured price cap regime, given carrier incentives for greater efficiency. Thus, it is not surprising that
the Commission consistently declined to engage in such a repricing or reinitialization.}}

The FCC will have a very difficult time justifying a contrary decision here.^{⁽⁷⁴⁾ It cannot be
disputed that the forward-looking cost studies that would be required to implement the repricing
proposals would be massive and complex. The FCC previously, in the Local Competition proceeding,
delegated such detailed analysis to the states and proposes a similar delegation as an alternative here.^{⁽⁷⁵⁾
But, as evidenced in the ongoing state arbitration proceedings, some states may lack the resources to
accomplish the requisite analysis within a reasonable timeframe.^{⁽⁷⁶⁾ Nor can it be expected that a generic
cost model can be devised which would permit the extrapolation of costs in one study area from those
in another, as illustrated by the demonstrated unreliability of the FCCs proxy rates for interconnection,
which were based on data from only a very few study areas.}}}

Accordingly, the practical problems and immense resource commitments required to implement any version of the FCCs repricing or reinitialization proposals pose an insurmountable barrier to adoption of those alternatives.

A. The FCCs Other Proposals For Modification Of The Existing Price Cap Regime Also Should Not Be Adopted (¶¶231-235)

As the FCC acknowledges, various elements of its existing price cap regime are under reexamination in other proceedings.^{⁽⁷⁷⁾ Those proceedings are the appropriate forums for addressing
possible adjustments in the price cap rules concerning rate of return or the productivity factor. At a
minimum, the record developed therein would not (as least directly) be affected by the FCCs evident
intention in this proceeding to circumvent the Eighth Circuits stay and coerce the implementation of its
confiscatory interconnection pricing rules.}

In any event, it is self-evident that reinitialization of price cap indices on the bases suggested by the Commission would be counterproductive. Adjusting price cap rates or indices to correspond to the FCCs vision of forward-looking, most efficient technology costs would cause price caps to reflect the most efficient operations theoretically possible, but would never actually be achieved, by any carrier. Thus, incentives for increasing efficiency of carrier operations would not be advanced. Rather, because no carrier could ever achieve the modeled level of efficiency, it will always be worse off by increasing its investment. As a result, the combination of such a reinitialization with the FCCs interconnection pricing requirements would wholly remove any incentive to build, upgrade, or maintain telephone company networks. As a result, the entire rationale underlying price cap regulation would be vitiated. Such a consequence cannot be squared with the public interest. Moreover, another fundamental Act objective -- increasing telecommunications investment -- would be completely undermined.

1. In A Competitive Environment, No Productivity ("X") Factor Is Necessary (¶¶ 231-235)

In competitive markets, automatic productivity reductions are simply unnecessary, because competition provides the necessary price discipline. Yet current rules require the X-factor be applied uniformly to competitive and non-competitive services alike. For LECs subject to even a limited amount of competitive entry, the perverse effects of such automatic, compounding productivity reductions are doubly crippling. They reduce rates in highly competitive markets. Yet they also reduce rates in rural markets where costs are high and current prices inadequate to cover geographic specific costs. In these low- (or no-) margin markets they prevent needed rate rebalancing and artificially deter competitive entry.

We are more subject to this whipsawing effect than any other LEC. We have a few highly competitive metropolitan areas, where the number of collocation arrangements far exceeds the number for any other state -- indeed, they comprise not far from half the nations total. We have 206 collocation cages built in 79 wire centers. These offices account for over 75% of Pacific's traffic. We also have a vast low-density area -- perhaps two-thirds of our wire centers -- from which, as a whole, we derive little or no contribution to total costs. Our California basic service prices are also relatively low, i.e., highly subsidized in low-density areas. All of this leaves us highly reliant on intraLATA toll services to fund our toll costs. IntraLATA toll is now subject to competition and fast being eroded.

When all of this is considered together, automatic price reductions from an artificial productivity factor prohibits us from investing in our network.

1. Alternatively, Productivity Could Be Set Equal To The GDPPI Inflation Factor (¶¶ 231-235)

The price reductions caused by the productivity factor are in addition to the price reductions given in response to market demands. Thus, under the current price cap plan, we must absorb both the financial impact of competition and the application of a formula that was intended to act as a surrogate for competition. We propose to eliminate the GDPPI minus X equation similar to action taken in California in 1995.^⁽⁷⁸⁾

The dual forces of competition and X-factor formula cause perverse results. GDPPI minus X requires anticipated productivity gains to be distributed evenly across baskets. Therefore, even though the targeted price reductions forced by competition may erode our earnings severely, application of this equation may mandate additional price reductions. The additional price reductions can jeopardize our financial integrity, despite our best efforts to minimize production costs in all aspects of our operations.

There is evidence that LEC productivity results will be reduced by the market changes envisioned in Phase 1. Christensens analysis^{⁽⁷⁹⁾ indicates that the restructuring of access charges could
cause measured productivity to slow by about 0.4%. This deceleration comes about from a shift in
revenue sources from rapidly growing demand units (minutes of use) to slower growing or declining
demand units (presubscribed lines, public policy funds, universal service funds). And as LECs lose
market share, productivity can slip by another 0.6% to 1.0% for every 1% decline in output growth.
Together these factors cause TFP to decline by 1.0% to 1.4%; the loss could be higher depending on
competitive assumptions.}

The long term growth in telecommunications total factor productivity has exceeded the U.S. economys productivity by about 2%. With LEC productivity dropping by 1.4% the productivity margin of the LEC industry is eroded sharply and the continued role of X in the price cap formula is questionable. With GDPPI minus X eliminated, Pacific assumes the risk of inflation. If inflation rises and the pressure on costs accelerates, Pacific has no automatic recourse to higher rates. A constant price over an extended period guarantees that real prices will fall at the rate of inflation. Therefore, not changing prices is equivalent to an indexed price cap where the productivity factor equals the rate of inflation.

Setting GDPPI equal to X, or its elimination, removes a growing source of controversy -- the measurement of productivity. Dr. Christensen for USTA has developed a comprehensive measure of LEC TFP. This model utilizes economic concepts appropriately and is fully documented and verifiable. In contrast, the IXCs have developed estimates of productivity that are wholly inadequate. The AT&T model, for example, is so filled with such serious logical and methodological errors that its results are virtually useless for regulatory purposes. Dr. Christensen critiques this model and documents its many faults, in Attachment 6 to USTA Comments.

Even by setting the X factor equal to GDPPI, we will continue to have incentives to operate efficiently. Competition has taken the place of the price cap formula to provide an incentive for us to operate efficiently. We know that we must continue to be efficient, or lose. In order to profit, we will have to overcome inflation, a substantial risk that we would assume under an approach that set productivity equal to the GDPPI inflation factor. An artificial X factor is unnecessary.

1. Sharing Should Be Eliminated From The Price Cap Plan

As we have stated in the 94-1 docket, sharing has no place in a properly crafted price cap plan. Sharing serves to recapture the efficiency gains made by the carrier and deprives the LEC of the benefits of those gains. By eliminating sharing, incentives for efficiency will be maximized. Sharing also discourages new deployment of infrastructure and technology. By capping overall returns, and not just prices, sharing handicaps the LECs ability to attract the tremendous sums of capital that infrastructure investment requires. Moreover, sharing increases administrative burdens on carriers and the Commission. Its elimination would free the Commission from having to micromanage and review a complex and often politically motivated system of cost allocations. Fourth, the measurement of interstate earnings, which result from subjective and sometimes arbitrary judgments about separations and depreciation rules, is increasingly devoid of economic meaning.

In addition, the purpose of the sharing mechanism was to provide a "backstop" for errors in the Commissions estimates of LEC productivity.^{⁽⁸⁰⁾ This is no longer a concern after 7 years of actual
experience under price caps. And, with the proposal herein to eliminate the productivity factor, or to
set it equal to inflation, no backstop is necessary. Sharing is a throwback to rate-of-return regulation,
which has no place in a pro competitive, deregulatory market.}

1. There Is No Basis to Reinitialize Price Cap Indices Based for a New Rate of Return Prescription

As the Common Carrier Bureau observed in the Notice announcing its Preliminary Rate of Return Inquiry,^{⁽⁸¹⁾ the Commission's rate of return prescriptions have little relevance to price cap
carriers. Moreover, the Commission itself recognizes that any attempt at represcribing price cap
carriers' rate of return must take into account not only changes in the cost of capital, but also the new
competitive environment.^{⁽⁸²⁾ Pacific believes that, given the demonstrated level of existing competition in
California, its stockholders' return should appropriately increase as a result of increased risk.
Nonetheless, since rate of return represcriptions are not directly relevant and do not trigger decreases in
the price cap indices, this issue is moot.}}

I. LECS ARE ENTITLED TO FULL COST RECOVERY OF CURRENT COSTS AND CAPITAL DEPRECIATION RESERVE DEFICIENCY AMOUNTS (¶¶ 241-270)

Whatever new structure is put into place as a result of this proceeding, the Commission must address how to compensate LECs for the difference between current revenues and the revenues that revised access charges are likely to generate. As shown earlier, the Commission also has a duty not to shift revenue requirements or adjust separations without referring the matter to a Federal-State Joint Board under section 410(c).

A. Recovery Of All Costs Is Compelled By The Communications Act And Is Necessary To Avoid An Unconstitutional Taking Of ILECs Property (¶¶247-260)

The Commission asks whether incumbent LECs are entitled to recover all or a portion of the difference between their interstate-allocated embedded costs and "forward-looking economic costs" that might result from any new access charge framework.^{⁽⁸³⁾ As discussed below, the Commission is
legally obligated under the Communications Act to permit ILECs to recoup all costs, including
embedded costs such as those costs associated with underdepreciation of assets, which will not be
recovered through other regulatory mechanisms including universal service support funds. In addition,
the failure to allow recovery of all embedded costs would amount to an unconstitutional taking of
ILECs property without just compensation and break the long-standing "regulatory bargain" between
incumbent local exchange carriers and the Commission. In the Affidavit of Sidak and Spulber attached
to the comments of USTA, compelling arguments are made as to why LECs are entitled to receive all of
their economic costs, both forward looking and historic.}

Recovery of all costs is required in establishing "just and reasonable" charges pursuant to Section 201(b) of the Communications Act.^{⁽⁸⁴⁾ ILECs have incurred significant actual costs in
developing and maintaining high quality service to all consumers at prices established by the
Commission and state regulatory entities. ILECs have been unable to recover all of these actual costs
as a result of unrealistically long depreciation schedules and the failure of such schedules to account for
decreases in asset value with technological innovation and competition. Therefore, any rate or charge
for access service that fails to include such costs cannot be "just and reasonable" because ILECs would
be denied costs incurred with the assurance of recovery, including a fair return on investment.}

Further, it is settled that the Fifth Amendment requires that a utility must be permitted to charge rates that are sufficient to maintain financial integrity, attract capital, and compensate investors for their risk-adjusted investment.^{⁽⁸⁵⁾ The constitutional issue is particularly acute with respect to
embedded costs in the telecommunications industry given the historical relationship between carriers
and regulators under which ILECs agreed to provide quality service at affordable prices to all
consumers in exchange for the opportunity to recover compensation for providing service and a
competitive return on invested capital.^⁽⁸⁶⁾}

The magnitude of the differential between ILECs actual embedded costs and "forward-looking" costs can be dramatic. For example, Pacifics current costs for an analog switch port are about $500. The forward-looking cost of that port, based on digital technology, is only about $20. Limitation of Pacifics access cost recovery to $20 would deny it compensation for its actual, prudent expenditures--that could not be recovered more quickly due to regulatory constraints--much less permit it a reasonable profit. Thus, the failure to allow ILECs to recover all such embedded costs would negate their reasonable expectation to receive a competitive return on invested capital, thereby denying ILECs the ability to receive just compensation for their property.

A. The Capital Reserve Deficiency Is Substantial And Must Be Recovered (¶¶249-255, 266-270).

The Commission notes that under depreciation can occur (1) if the useful lives prescribed for regulated facilities exceeds the economic lives of those facilities; and (2) if the depreciation procedures do not recognize the decline in the economic value of plant already in service that occurs when the replacement cost is less than the cost of the older equipment.^{⁽⁸⁷⁾ We agree.}

In 1995 Pacific Bell discontinued use of SFAS 71 and recognized a one-time charge to our external financial reporting of $5.7B pre tax and $3.3B after tax. That charge recognized that regulation may no longer assure recovery of total investment on our books. Pacific currently carries a significant reserve deficiency on its regulatory books because past FCC depreciation practices have not allowed us to depreciate our assets as fast as these assets were losing value due to technological obsolescence, and due to the impact of increasing competition. The study we have undertaken to quantify the reserve deficiency differs from the method used by the USTA in its filing with respect to how and when the deficiency is recognized. Pacific has chosen to reflect the entire amount as an immediate impairment of our assets, while USTA has viewed the deficiency over the remaining lives of these assets. Pacifics reason for recognizing the entire deficiency today is our assessment of continuing regulatory burden in the increasingly competitive environment in which we operate; it recognizes the unique competitive pressure we face in California. As we lose customers and revenue to competition we lose the ability to recover these investments. Our calculation of our reserve deficiency is $4.4B, the interstate portion of which is $1.0B. See Declaration of Terry Orr, attached. The USTA method, on the other hand, yields a calculation of $2.3B, the interstate portion of which is $500M. While that number is included in the USTA industry roll up, the greater number of $1.0B is more appropriate for a competitive environment such as California.

Recovery of dollars due to the capital depreciation reserve deficiency should be accomplished via a 5 year amortization, as USTA has proposed.

A. The FCC's "Market-Based" Transitional Mechanism Will Not Permit ILECs to Recover All Remaining Costs (¶¶260-270)

In its Notice, the Commission also seeks comment on the proper recovery mechanism in the event that it determines that incumbent LECs are permitted to recoup all or part of the difference in "revenues generated by access charges based on embedded and forward-looking costs."^{⁽⁸⁸⁾ In particular,
the Commission seeks comment on both a so-called "market-based" recovery mechanism and a more
regulated approach, which could include recovery through an amortized schedule recovered through
access charges or a separate "surcharge" to recover all interstate allocated costs.^⁽⁸⁹⁾}

While a market-based approach is necessary for pricing, the Commission cannot adopt a "market-based" transitional mechanism because that does not allow ILECs to recover all remaining embedded costs. As the Commission characterizes its "market-based" approach, an ILEC would be given "pricing and rate structure flexibility" and the "opportunity to reduce their cost of service levels" during a transitional period while competition is "still developing."^{⁽⁹⁰⁾ The Commission's approach thus
assumes that incumbent LECs can successfully recover embedded costs from some segment of
subscribers after the FCC has removed previously existing cost-recovery mechanisms. However, this
approach will not work due to existing competitive pressures in the market for access services.
Moreover, as the Commission acknowledges, any increase in the percentage of costs allocated to the
intrastate jurisdiction might further exacerbate the difficulty in giving incumbent LECs a "reasonable
opportunity" to recover all or some of their embedded costs.^⁽⁹¹⁾}

As noted earlier, competition in the access service market in California is already underway, particularly with respect to low-cost, high-volume customers such as large businesses and interexchange carriers in major metropolitan cities.^{⁽⁹²⁾ The fact that competition exists in California today
means that Pacific does not have the luxury of pricing "flexibility" that would be sufficient to allow the
recovery of its embedded costs. Instead, Pacific will be faced with increasingly downward pressure on
access rates for customers served by competitive providers, and other customers -- including residential
and small business subscribers -- will remain as the only market where it may recover embedded costs.
Such an approach, however, would not only unfairly burden a limited group of customers, but would
also make full recovery impossible given the limited ability of these customers to absorb the anticipated
revenue difference. Accordingly, the Commission must adopt a recovery mechanism that ensures
Pacific and other ILECs an opportunity to recoup such costs in a manner that is equitable to both the
local exchange carriers and ratepayers.}

A. Universal Service Support Will Not Amount To Double Recovery For Access Charges (¶¶242-246)

Carriers will receive payments from the universal service fund when serving high cost customers that meet the criteria established by the Commission in the Universal Service proceeding. The Commission seeks comment in this Notice about how the price cap indices will be adjusted to account for any proceeds from the new universal service fund.^{⁽⁹³⁾ We agree with the Commission that a
downward exogenous cost adjustment is appropriate to reflect any additional revenues received from
the fund, as long as two conditions are met. First, the downward exogenous adjustment should be
made only to the extent there is a net revenue increase to the carrier from the fund. Second, to the
extent a LEC is precluded from directly passing through its contribution amount to its customers
(through a surcharge or other customer charge), an upward exogenous adjustment should be made.}

Section 254 of the Act requires the Commission to institute a universal service plan which, on the basis of nondiscriminatory and equitable payments provides specific and predictable support mechanisms to ensure service in rural and high cost areas. The Commission in this Notice seeks comment on whether the retention of the current access charge system, such as the CCLC, could compensate incumbent LECs twice for providing universal service, and what steps the Commission could take to address any potential double recovery.^{⁽⁹⁴⁾ The exogenous adjustments we have outlined
above ensure that no double recovery will occur.}

The universal service support mechanism takes into account the revenue received for serving the customer, from whatever source that revenue originates. Thus, for a residential subscriber, the monthly basic service rate, the SLC and the CCL-equivalent charge (whether assessed per minute or via a bulk-billed amount) are included in the subsidy calculus. A carrier will not be overcompensated as long as the universal service fund includes both costs incurred and revenues received and adjustments are made to correct access charges to reflect Universal Service funding. Not only will a carrier not be overcompensated in this situation, but if the Joint Board recommendation is adopted without modification, rates will necessarily continue to include subsidies due to the Joint Board's proposed inclusion of inappropriate and subsidizing rates in the benchmark formula.^⁽⁹⁵⁾

A. Future InterLATA revenues cannot recover embedded costs (¶256)

The Commissions own rules, discrimination standards, and market conditions in the interLATA market foreclose the use of an affiliate's interLATA revenues to fund shortfalls in access recovery. At the outset, it should be noted that any such scheme would amount to nothing more than an increase in access charges to the BOCs interLATA affiliate, as compared to the access rates faced by other interLATA providers. This could in no way be squared with the Acts fundamental discrimination standard that interLATA providers should face the same charges for access to the local network. Moreover, singling out the BOC affiliate in this fashion would simply force the BOC to charge more for the toll it offered to end users, thus hurting both competition and consumers. Such an outcome would thus bear the negative marks of being unlawfully discriminatory and harmful to competition and end users.

In addition, in the Commissions recently released order in Docket 96-150 (Accounting Safeguards), as well as Docket 96-149 (Structural Safeguards), it has made clear that the interLATA affiliate has to operate on a separate basis from the BOC. The Act itself requires this same standard (See Section 272 and the "operate independently" rule). As a legal matter, the BOCs interLATA affiliate must operate as a completely separate entity, with strictly separate books of accounts from the BOC. Since this separation is required by law and the Commissions own decisions, there is no legal basis for undoing these requirements and forcing the BOC's affiliate to specially fund the BOC's cost of providing local access to interLATA toll providers.

Finally, there is good reason to conclude that the interLATA toll market cannot sustain a special funding obligation placed only on BOC interLATA affiliates.

The prospect of future revenues from a BOC affiliate's interLATA services is not a solution to the need to recover todays costs with todays access charges. The Commission has already found the interLATA market to be competitive though, as we point out elsewhere, there is great reason to question whether consumers are seeing any benefit from this "competition". With additional LEC entry, that market will become more competitive and consumers will actually be benefited. Under such a market condition, LECs' interLATA affiliates can reasonably hope to recover forward-looking costs and reasonable profit from interLATA service itself, but will have no ability to recover the remaining interstate-allocated embedded costs of access service.

Moreover, the Commission, in its non-accounting safeguards order, has made it virtually impossible for a BOC to use facilities it now owns to provide interLATA services to its affiliates or others notwithstanding that the Act envisions that a BOC may provide interLATA facilities and services to its interLATA affiliate and to other interLATA carriers.^{⁽⁹⁶⁾ While this would possibly allow BOCs to
derive an additional source of revenue from its existing plant with some incremental investment, the
Commission has ruled that the Act does not allow the BOC to use its facilities in this way.^{⁽⁹⁷⁾ Thus,
under the Commissions reading of the Act, it will be impossible for a BOC to realize any interLATA
revenues that could ameliorate any shortfall in access revenues. In any event, even this approach
envisions like charges to the BOC's interLATA affiliates and its competitors.}}

I. CARRIERS SHOULD NOT BE ALLOWED TO ENGAGE IN UNECONOMIC ARBITRAGE UNDER THE COMMISSIONS RULES AND AVOID PAYING THEIR FAIR SHARE OF UNIVERSAL SERVICE OBLIGATIONS BY USING UNBUNDLED ELEMENTS TO PROVIDE EXCHANGE ACCESS SERVICES (¶54)

The Commission must reconsider its tentative conclusion that carriers purchasing unbundled elements for use in providing exchange access services should be excluded from the access charge regime.^{⁽⁹⁸⁾ Access rates have never been determined solely based on costs, unlike unbundled
elements, but have been set at their current levels to satisfy a number of social policy goals. Allowing
carriers to avoid paying these charges will undermine universal service supports, prevent ILECs from
recovering their costs, and cause inefficient entry into the exchange access market.}

In its Local Competition Order, the Commission attempted to make a similar finding. Rule 51.515(a) states that "[n]either the interstate access charge described in part 69 nor comparable intrastate access charges shall be assessed by an incumbent LEC on purchasers of elements that offer telephone exchange or exchange access services." However, that rule was stayed by the Eighth Circuit.^{⁽⁹⁹⁾ Because of this stay and because "access charges have always played a complex and critical
role in the recovery of embedded network costs," the CPUC recently decided to apply access charges to
unbundled elements used for toll calling.^{⁽¹⁰⁰⁾ Indeed, the FCC itself noted that a transitional mechanism
was needed before access charges could be eliminated from unbundled elements used to provide
exchange access because "allowing such a result before we have reformed our universal service and
access charge regimes would be undesirable as a matter of both economics and policy, because carrier
decisions about how to interconnect with incumbent LECs would be driven by regulatory distortions in
our access charge rules and our universal service scheme, rather than the unfettered operation of a
competitive market."^{⁽¹⁰¹⁾ Until (1) the pricing policies governing access and unbundled elements are
conformed, (2) ILECs are provided with another mechanism for recovering their actual embedded
costs, and (3) the universal service funding mechanism is made explicit and predictable as required by
Section 254, carriers using unbundled elements to originate or terminate toll traffic should be required
to pay the difference between the cost of the unbundled network elements and the access charges they
would be required to pay if they purchased such services directly from the ILEC.}}}

A. The Current Access Charge Rules Include Actual Costs As Well As Several Subsidies In Access Rates To Support Below-Cost Residential Telephone Service Rates (¶54)

The current access charge regime is designed to keep local service rates below cost through higher long-distance charges, not to approximate the actual costs of providing exchange access services. Access charges are based on fully distributed cost (FDC) pricing, including recovery of ILEC actual costs, all of which would have been disallowed under the Commissions unbundled element pricing rules had they not been stayed. In adopting the FDC method, the Commission concluded that although costs should be the basis for determining rates of particular services, "statutory and social policies may lend sanction to some intraservice subsidies."^{⁽¹⁰²⁾ Access charges are now regulated under
the price cap regime; the rates that originally went into price caps were established by rate-base, rate-of-return regulation.}

In addition to keeping local rates below cost, access charges contain subsidies used to support several aspects of universal service, including service to high-cost areas.^{⁽¹⁰³⁾ For example, the
high cost assistance fund allows LECs with above-average loop costs to recover their additional costs,
with each LECs embedded costs determining the support payments the LEC will receive. Lifeline and
Link Up provide IXC funded support for low income individuals. Also, DEM weighting allows smaller
LECs to attribute a greater portion of local switching costs to the interstate jurisdiction. The actual
DEMs are weighted to shift costs that would otherwise be attributed to the intrastate jurisdiction to the
interstate jurisdiction.^{⁽¹⁰⁴⁾ In addition to these explicit subsidies, the residual loop costs are not recovered
fully through the subscriber line charge and are thus recovered through the CCLC.}}

The current separations rules allocate 25% of exchange loop costs to the interstate jurisdiction, where they must be recovered from access charges.^{⁽¹⁰⁵⁾ This percentage is substantially
greater than the relative usage of joint plant for access purposes.^{⁽¹⁰⁶⁾ Because of this, the access charges that must be assessed to cover the costs assigned to the interstate
jurisdiction are greater than the actual costs of providing that service. Therefore, even if interstate
access charges were based on the same definition of recoverable costs as unbundled elements, these
charges would still be higher than actual costs incurred to provide access because such charges would
be set to recover 25% of the costs of jointly used plant rather than the much smaller percentage that is
actually used to provide interstate service.}}

A. Permitting Carriers To Avoid Access Charges By Purchasing Unbundled Elements Will Allow Them To Avoid Contributing Their Fair Share To The Provision Of Low Cost Residential Service While Preventing ILECs From Recovering Their Costs And Competing In The Exchange Access Market (¶54)

Access charges are virtually the only method currently authorized through which ILECs can recover the interstate allocated costs of local exchange plant, as well as the subsidies necessary to provide below-cost local service and further universal service policies. If carriers are allowed to avoid these charges through the purchase of unbundled elements, ILECs will have no opportunity to recover their costs, resulting in an unconstitutional taking, and will not have a fair opportunity to compete in the exchange access market. Under the Commission's stayed pricing rules, unbundled elements were to be priced based on only the actual costs attributable to that network element, without any of the universal service subsidies or separations adjustments discussed above. In addition, the Commission proposed that the prices for such elements should be forward-looking, and not include any embedded costs.^{⁽¹⁰⁷⁾
Thus, access to the local network can be significantly less expensive when obtained through unbundled
elements as opposed to switched access.^{⁽¹⁰⁸⁾ Such a pricing differential will encourage inefficient entry
into the exchange access market, as the Commission noted.^{⁽¹⁰⁹⁾ Carriers will simply "arbitrage" the
separations and access charge rules in order to gain less expensive access.^{⁽¹¹⁰⁾ BOCs, and their
shareholders, will be left with paying for the cost of such access.}}}}

Using California data for Pacific Bell, allowing carriers to obtain cheaper access through use of unbundled elements will benefit only the 30 percent of residence customers who will be targeted by CLCs. This 30 percent of the residential market makes more than 75 percent of the intraLATA and interLATA toll calls and, because access charges are usage-based, contribute substantially to the subsidies needed to preserve low universal service rates. If the Commission allows CLCs to use unbundled elements to obtain cheaper access and offer better rates to this 30 percent of the customers, the ILECs will be left with no source of funding to support reasonable rates to the remaining 70 percent of residential consumers. In order to allow recovery of ILEC costs of providing basic access, the Commission must ensure that when unbundled network elements duplicate exchange access service, the rates are the same.

Most importantly, Congresss universal service goals require contributions by all telecommunications carriers. The Commission has yet to make a final decision how it will meet the universal service mandates included in the Act, and the Joint Boards Decision did not address the major issues regarding how the universal subsidies should be allocated. In addition, the Commission determined in the Local Competition Order that ILECs embedded costs should be recovered through universal service and access charge reform.^{⁽¹¹¹⁾ Because access charges have historically--and will
continue in the near future--to be the most important source of universal service funding and embedded
cost recovery, the Commission must consider how it will structure these subsidies before fundamentally
altering the access charge regime. In the interim period, if carriers are allowed to circumvent the access
charges, ILECs will have no incentive to invest in their networks and will be unable to continue to
provide affordable local service.}

A. Until Such Time As Access Charges Are Priced Consistently With Unbundled Network Elements, Carriers Using Unbundled Elements To Obtain Exchange Access Service Should Be Required To Pay The Difference Between The Cost Of The Unbundled Network Elements And The Access Charges They Would Be Required To Pay If They Purchased Such Services Directly From The ILEC (¶54)

Even if the Commission is ultimately able to make access charges cost-based, implement a separate scheme for the recover of ILECs embedded costs, and revise the separations rules so that they accurately reflect the way costs are incurred, a transition period will be required. During this period and until such time as all the necessary adjustments have been made, the Commission should require that carriers using unbundled elements for exchange access pay the difference between the cost of the unbundled elements and the access charges they would have otherwise incurred. This will ensure that each carrier is contributing its fair share to the support of universal service and that the ILECs have the opportunity to recover their costs and compete in the exchange access market.

Such an approach will not require extensive and intrusive Commission rules. In order to further its goal of limiting regulation and recognizing that competition in all telecommunications markets will continue to increase, the Commission should simply require that the difference between the ILECs access charges, regardless of whether they are determined by the market or by the Commission, and the cost of access through unbundled elements be paid to the ILEC. The ILEC and interconnecting carrier should be allowed to determine the actual rates through negotiations and interconnection agreements. Since state commissions must review all interconnection agreements, there will be sufficient oversight to ensure that AT&T, MCI, and other CLCs do not use their purchasing power to force the majority of these costs on to the 70 percent of customers they do not intend to serve. The Commission should note that although Pacific strongly believes that a market-based system is best for determining access charges, this approach is consistent with either market-based rates or Commission-set rates.

I. RATE STRUCTURE MODIFICATION

The current rate structure has been in effect for approximately 13 years. Those 13 years have seen tremendous change in the telecommunications industry. The access charge structure must reflect today's competitive environment, where users should pay for the costs they incur, and subsidies should be uncovered and made explicit. We generally support the structure proposed by USTA in its Comments.

We agree with the Commission that whichever approach to access restructure is chosen, prescriptive or market-based, more economically rational rate structure rules are necessary and appropriate. Our proposal is as follows: First, to the extent possible the CCLC should be reduced or eliminated. This can be accomplished by increasing the SLC caps, or by allowing the multi-line SLC to increase to its cap. Any residual CCL should be recovered on a bulk-billed basis from access customers on the basis of presubscribed lines. Second, rate elements should be charged in the way the costs are incurred; for example non-traffic sensitive costs should be charged on a flat-rated basis, and usage sensitive costs should be recovered on a usage sensitive basis. Third, we support reallocating portions of the TIC to their appropriate elements that better reflect cost causation. The remainder of the TIC should be bulk-billed to access customers based on interstate revenues.

A. Common Line Costs Should To The Extent Possible Be Charged To End Users And Should Be Permitted to be Deaveraged (¶¶ 57-70)

Common Line costs are currently recovered through a flat-rated end user charge, the SLC, and through a usage sensitive charge, the CCLC. SLCs are limited to the lower of the per-line cost of the interstate portion of the local loop or $3.50 per month for residential and single line business users, and the lower of the per-line cost or $6.00 per month for multi-line business users. Any residual amounts resulting from the imposition of the cap is recovered through the CCLC, which is a per minute charge levied on access customers.

The fundamental repricing ordered by the Telecommunications Act was to eliminate subsidies, make them explicit, and collect them from all carriers on a competitively neutral basis. We agree with the FCCs fundamental goal that prices move towards cost and subsidies be removed; economics dictate this. If prices on services which provide subsidies move toward cost, however, then prices on subsidized service (consumer prices) must equivalently move toward cost or a subsidy mechanism must be developed which includes 100% of the subsidies instituted by the regulators over the last 50 years. Pacific has been a leader in championing alternative, subsidy mechanisms, at the state and federal levels. But, in the absence of a sufficient fund or funds, the prices of subsidized services must be increased to assure full cost recovery. Our position therefore includes an increase in the SLC.

As Chairman Hundt said in 1995,

We need to fix the Carrier Common Line Charge. This part of access charges works to make high-volume users subsidize lower-volume users.... as competition hits the local exchange market the system cannot continue. The fact is that the CCLC tends to drive access charges way above cost....

If we fix the CCLC, then obviously we need to take a hard look at the hard caps on the Subscriber Line Charge. These charges are the two sides of the coin paid for access. Internet customers pay a flat rate; isnt it time to rely more on flat rates in local loop pricing? We need to find ways to let the subscriber line charge caps approximate economically rational pricing for consumers and single line businesses....

We should be concerned about price shocks rocking consumers. But, we shouldnt be concerned about nickel and dime differences on the local telephone bill at the expense of having rational pricing.^⁽¹¹²⁾

We agree with Chairman Hundt that the CCLC is unsustainable in a competitive environment. Increasing the SLC may be the only way to encourage prudent investment in the network by allowing carriers to recover their costs. We also propose that LECs be permitted to deaverage the SLC to better reflect the variability of loop costs. Such a charge would be competitively sustainable in that end users would be paying for the interstate portion of the costs incurred to serve that end user.

1. The Subscriber Line Charge ("SLC") Rate Structure Should Be Modified and Geographically Deaveraged (¶¶57-67)

One approach for common line recovery is to eliminate the arbitrary cap of $3.50 per month on residential and single line business subscribers. The $3.50 cap was instituted in 1989 as a transition method for recovering non-traffic sensitive loop costs directly from the cost causers--end users. Beginning in 1985, the SLC was set at $1.00 per line, then transitioned to $3.50 over 4 years. Since 1989, the SLC cap has been set at $3.50 and has not increased, even to keep pace with inflation.^{⁽¹¹³⁾ If the $3.50 cap were eliminated, and the $6.00 cap retained for all customers, the Pacific
Bell geographically averaged SLC price for all business and residence customers would be only $4.75.
The total price effect on consumers would be minimal,^{⁽¹¹⁴⁾ but the overall effect would be positive. It has
been shown that during the 1980s, increasing line charges and decreasing toll charges did not merely
balance one another out, but led to overall increases in consumer welfare.^{⁽¹¹⁵⁾}}}

Treating residential and business subscribers similarly is justified by the continued blurring of the line between the two. Increasingly, residential subscribers, through telecommuting or work-at-home programs, use the residence line for business purposes. National market research estimates that over 5.5 million households in California, and over 40 million households nationwide, perform some work at home.^{⁽¹¹⁶⁾ A significant number of work-at-home households require multiple
lines to accommodate faxing, networking, and paging. The current FCC rules, which set separate SLC
costs for residence and single line business, and multi-line business, are based on a technological past
where home offices were unusual, where most households purchased few telecommunications services
beyond a single primary line and perhaps a few room extensions, and where that home line was almost
never used for business purposes. By maintaining this artificial distinction in its pricing structure, the
FCC is ignoring the technological and workplace revolution which has swept the U.S. over the past
decade; it is holding on to a pricing structure impossible to maintain and easy to abuse.}

It also is increasingly difficult to decide which lines are reserved for residential versus business usage; indeed many lines labeled "residential" today are used as much or more for business purposes as for other purposes. Thus, the distinction of residential over single line business versus multi-line business is becoming meaningless as household telecommunications moves increasingly toward multiple lines used for a multitude of purposes.

If the Commission is unwilling to eliminate the $3.50 cap for residence and single line business, we support in the alternative eliminating the limitation that requires the multi-line business SLC to be the lower of the $6.00 rate cap or the calculated rate per 47 C.F.R. 69.104(c). Over 40 states have multi-line SLC rates that are at the $6.00 cap. Pacific's are substantially below the cap ($4.75). As the experience of most of the rest of the country illustrates, permitting us to raise the SLC to the $6 cap will not adversely affect consumers and will permit costs to be shifted toward the end user customer.

SLCs should be permitted to be geographically deaveraged, whether or not the caps for residence or multi-line business are adjusted. Geographic deaveraging is necessary to reflect the variation of costs with population density and geographic characteristics. Pacific Bell's recent (January 13, 1997) compliance filing at the CPUC reflected geographically deaveraged loop costs--further proof that SLCs should similarly be deaveraged to reflect loop cost differences. The Commission correctly notes that geographic averaging of SLCs is one form of implicit subsidy^{⁽¹¹⁷⁾ in that
end users with low loop costs provide contribution to end users with high loop costs. This presents a
structure which is not economically rational^{⁽¹¹⁸⁾ and not sustainable in a competitive market; our
competitors can easily target our high volume users with low loop costs. Deaveraged SLC pricing
minimizes this effect. More flexibility in recovering loop costs will decrease incentive for uneconomic
bypass of our network.}}

The Commission proposes to increase the cap on the SLC for second and additional lines for residential customers. Or, the Commission proposes, it could eliminate the cap completely, freeing the LEC to charge SLCs in excess of the cap to second residential lines. The Commission should not adopt these proposals. First, this policy will create severe identification difficulties when a customer obtains lines from multiple carriers because it will be impossible to determine which carrier's line is the "primary" line. Perverse incentives will result; CLCs can then target second lines in dense areas, so that both ILECs and CLCs each serve a customer with a "primary" line. Second, with multiple carriers, if the first line obtained is always considered the primary line, a competitive advantage will be accorded to the current provider. Third, as we explained in our comments in Docket No. 96-45, determining whether additional lines in a single residence actually belong to multiple households, and whether a home is a "second residence," is a nearly impossible task. Increased second line charges will be an unworkable solution, since no one will admit to owning a second line. Accordingly, the Commission should treat all lines equally and not make a distinction in the SLC cap for second lines.

1. Any Residual Carrier Common Line Charge ("CCLC") Should Be Recovered On A Flat-Rated Basis (¶¶ 59-63)

In its Recommended Decision, the Universal Service Joint Board found that: "Because the cost of a loop generally does not vary with the minutes of use transmitted over the loop, the current CCL charge that mandates recovery of loop costs through per-minute-of-use charges represents an inefficient cost recovery mechanism."^{⁽¹¹⁹⁾ We agree with the Joint Board's conclusion. We support
recovering loop costs directly from loop purchasers so that residual loop costs that need to be
recovered through the CCLC will be eliminated, or at the least, minimized. Under the alternatives we
outlined above, we attempt to directly recover loop costs. To the extent residual loop costs remain and
need to be recovered from the CCLC, we support a bulk-billing based on the presubscribed lines of a
carrier.^{⁽¹²⁰⁾}}

Our current CCLC for California is relatively small once the payphone elements and Long Term Support payments are excluded. We estimate that the CCLC left in our rates after these adjustments will be around $100M.^{⁽¹²¹⁾. Based on current presubscribed lines, the bulk-billed amount will
be around $0.52 per line per month.}

1. SLCs On ISDN And Derived Channels (¶¶ 68-70)

The Commission seeks comment on how the Telecommunications Act of 1996 affects how many SLCs should be applied to ISDN services.^{⁽¹²²⁾ As we stated in our comments in the ISDN
proceeding, SLCs should be assessed on a per facility basis for both BRI and PRI ISDN service. ISDN
does not change the nature of a local loop. It is a switch feature that allows the local exchange line to
be used more dynamically and efficiently, but it does not change the fact that a single local loop is in
use. 47 C.F.R. 69.104 requires SLCs to be applied on "each line...that is or may be used for local
exchange service transmissions." Thus, the SLC for ISDN should be based on the facilities used, not
the derived channels.}

The cost data noted by the Commission in the Notice does not change this policy. It simply reinforces that for BRI, the ISDN product most in use and most useful for consumers, the difference between NTS costs of ISDN loops and standard loops is minimal. While there is some greater difference in NTS costs where PRI is provided, any additional revenues generated from imposing several SLCs on PRI service will be minimal given the low penetration of this service.

The Telecommunications Act of 1996 does not change any of these facts. What the Act promotes, however, is the removal of implicit subsidies. If multiple SLCs were imposed on ISDN service, those subscribers would be overpaying for the costs they have caused and an uneconomic subsidy would be created. We therefore support using a 1 SLC per facility rule for all service, including services with derived channels.

The Commission also seeks comment on whether mandatory rate structures or rate caps should be prescribed for ISDN or other derived channel services.^{⁽¹²³⁾ ISDN is not a federal service; it is
not an access service. Rather, it is a local exchange service. The FCC cannot involve itself in its
regulation. In fact, just recently, Chairman Hundt gave his opinion that even states should not regulate
ISDN service:}

After all, you can hardly argue either that regulation has effectively promoted this long-overdue service or that ISDN is a basic commodity that should be priced by rule at affordable levels. Why not give deregulation of ISDN a chance?^{⁽¹²⁴⁾}

Proposing to regulate ISDN at the federal level is inconsistent with this direction.

A. Local Switching Costs Should Be Recovered In The Way They Are Incurred (¶¶ 71-79)

Currently, the local switching rate structure is limited to a per-minute-of-use-basis, regardless of the way local switching costs are incurred. When the costs are examined, it is clear that local switching is multi-dimensional. Switch connection costs such as line and trunk port costs, do not vary with usage as do those incurred in the switch processing function. The rate structure must reflect these differences.

Both line and trunk ports should be recovered on a flat-rated basis, to the extent they connect to dedicated trunk and line facilities. The costs of trunk ports are currently recovered in 2 different rate elements. Digital trunk ports (trunk cards) are assigned to Local Switching and are included in Account 2212. On the other hand, analog trunk ports, which are pieces of equipment which perform the same function as digital trunk cards, are assigned to Transport and included in Account 2232, which is currently part of the Transport Interconnection Charge. The functionality is the same but the Part 69 assignments are different.^{⁽¹²⁵⁾}

The switch fabric is shared by many carriers, and its costs (which vary with usage) must be recovered on a usage sensitive basis. Because by definition a shared facility is not dedicated to a particular customer, a flat-rated structure would result in high volume customers subsidizing low volume customers. However, a trunk port serving common transport trunks^{⁽¹²⁶⁾ could also be considered
a "shared facility"^{⁽¹²⁷⁾ since it carries traffic from many IXCs and the LEC itself. The traffic load placed
on the common transport trunks, and their associated trunk ports is dynamic, changing from hour to
hour, day to day and month to month. There is no practical nor fair way to assess to an IXC a flat
monthly charge for the use of these trunk ports that are shared with other IXCs. Therefore, flat-rated
charges for shared facilities are inappropriate.}}

The local switch must establish a call path through the network and keep that path open during the course of the call. For a call to be set up, the originating switch must return dial tone, receive digits dialed and consult various tables in the switch to determine the type of call, whether the call is interLATA, and determine where to send the call. It also needs to determine whether it needs to route the call to an access tandem or whether the carrier has facilities directly from the end office. The switch then needs to find an idle trunk and establish signalling to the carrier alerting the carriers switch that the call will be coming. At this point, the switch then establishes the call path and receives the carriers acknowledgment of receipt.

These call set up activities do not vary based on the number of calls, or the duration of those calls. A 10 second call incurs the same call set up costs as a 10 minute call. The current rate structure, which requires a rate level based on the average length of a call puts in place the uneconomic structure which ensures that some calls (short in duration) do not recover their costs, while long calls subsidize those calls. A structure which recognizes the way costs are incurred, via a per message call set up charge and a per minute duration charge is a rate structure where cost causers will pay appropriate charges. One major problem with todays interstate switching rate structure is that short, transaction based calls (fax, credit card verification, debit card transactions, paging) are proliferating, and, due to the fact that call set up charges are not charged on each call, these transaction based calls are not paying local switching costs they incur.

It costs us almost five times more to set up a call than to provide a minute of use due to the heavy involvement of the switch processor in setting up calls. Permitting LECs to charge a separate per message call set up charge comports with sound economic principles and the Commissions goal of economic pricing based on cost causation principles.^{⁽¹²⁸⁾}

In California, we have had the call set-up and duration rate elements in place since January 1995, after the CPUC found that this rate structure better reflected cost causation principles than a simple minute of use structure.^{⁽¹²⁹⁾ The Commission asks if the call set- up charge should apply to
call attempts or only to completed calls.^{⁽¹³⁰⁾ Since 1984 originating charges have applied to all
originating access call attempts that are handed off to the POP, but are charged only to those
terminating attempts that complete. We propose the same for the newly proposed call set up charges in
the interstate jurisdiction as they do in California for intrastate access. In accordance with access
pricing principles,^{⁽¹³¹⁾ all originating attempts are billed because an originating attempt is deemed
complete when it is handed off to an IXC. For terminating access, we bill only when the call completes
to an end user. No change is needed to this access pricing principle.}}}

The Commissions decision in the Third Report and Order does not obviate the need for a rate structure which permits carriers to charge a call set up charge in addition to the per minute of use charge. The Third Report and Order permits carriers to file for new services without going through the waiver process.^{⁽¹³²⁾ However, instituting a call set up charge is not a new service, it is a restructure of an
existing service. As such, we would not be able to utilize the new procedures in the Third Report and
Order to accomplish this rate structure change.}

A. Transport Rates Should Be Structured To Reflect The Way Transport Costs Are Incurred, And Restructured So That Amounts In The TIC Are Reclassified To More Appropriate Rate Elements (¶¶ 80-122)

As with local switching, transport rates should reflect the way that costs are incurred. Because of the Commissions past decisions, transport rates require dedicated transport customers to pay for tandem switching (via the TIC) they do not use. The FCC correctly identifies that that to the extent a service involves dedicated facilities, such as entrance facilities and direct trunked transport, "flat-rates reflect the way incumbent LECs incur costs for dedicated facilities."^{⁽¹³³⁾ Flat-rated charges for
these services are consistent with Pacifics state access prices,^{⁽¹³⁴⁾ and its interconnection agreements.^{⁽¹³⁵⁾}}}

Similarly, flat-rated charges should also be structured to recover costs for that portion of the tandem switch which is non-traffic sensitive. Like the local switching trunk ports, the trunk ports on the SWC-side of the tandem switch do not vary with usage, and are dedicated to particular customers. The ports on the end office side of the tandem, however, are shared (just as the end office ports connecting to common transport trunks are shared), and should be treated similarly by retaining a usage sensitive charge for that connection.

Moreover, the tandem switch, like the end office switch, incurs different types of costs for setting up calls and keeping calls in place. Like our proposal for local switching, the tandem switching charge should include a per message call set up charge and a per minute charge for the length of the call.

The Commission seeks comment on what rate structure or structures should be permitted for tandem-switched transport. We support a combination of flat-rated (between serving wire center (SWC) and access tandem) and usage sensitive (between access tandem and end office). We support the latter since the SWC to tandem facilities, like those that directly connect the SWC to an end office (and which are flat-rated), are dedicated to an IXC and do not vary with usage. On the other hand, the common transport facilities (those connecting the access tandem to an end office) are not dedicated to an IXC and need to be priced on a usage-sensitive basis for the same reasons described above regarding common transport trunk ports.

The Commission asks whether it is appropriate to recover some portion of tandem switching costs from direct trunked transport service customers since the tandem stands ready to serve those customers during peak periods.^{⁽¹³⁶⁾ We support such a pricing structure as economically efficient
whether or not peak pricing is adopted. Dr. Emmerson states that "On efficiency grounds, customers
with random demands should pay for the extra cost incurred due to the uncertain nature of their
capacity requirements. Thus, direct-trunked transport customers should have to pay a standby charge
reflecting the added cost of accommodating their overflow traffic."^{⁽¹³⁷⁾}}

1. The Transport Interconnection Charge ("TIC") Should Be Disaggregated And Costs Assigned To Their Proper Rate Elements. Residual Amounts Should Continue To Be Billed To Access Customers On A Bulk Billed Basis (¶¶ 96-122)

The TIC represents interstate costs appropriately recovered through access charges. In accordance with the Commissions obligations to permit access charges to recover costs allocated to the interstate jurisdiction through the separations process, the Commission must permit the TIC to be adequately and completely recovered through our interstate rates.

We agree with the Commissions tentative conclusion to reassign costs into their appropriate access services. The Comptel remand requires "a cost based alternative to the RIC [TIC], or to provide a reasoned explanation of why a departure from cost-based ratemaking is necessary and desirable in this context."^{⁽¹³⁸⁾ Cost based ratemaking is a central tenet in the Commissions Notice. No
explanation has been proposed to justify a departure from this tenet. Thus, the TIC must be analyzed
and costs in the TIC reassigned based on the appropriate rate element.}

We have undertaken this analysis and can identify over 85% of the costs in our TIC. We believe that the 80% of the tandem revenue requirement contained in the TIC should be reallocated to the tandem switching rate. For Pacific, that amount represents about $28M of our $121M TIC. As we stated earlier in section B, approximately $25M of the TIC represents analog end office ports, which belong in the local switching rate. Other transport-related costs such as host-remote configurations and redefining tandem switched transport account for about $16M of the TIC and should be recovered in transport rate elements.

Various separations-related costs are contained in the TIC. These amount to about $40M, and are due to the way separations rules allocated COE maintenance, trunk termination count methodology, and interexchange cable and wire.^{⁽¹³⁹⁾ We expect that the upcoming proceeding on
separations reform will ultimately deal with these costs for a long term resolution. We agree with the
D. C. Court Of Appeals that the TIC "may in part reflect an excessive allocation of costs to interstate
rather than intrastate services under the FCCs Part 36 rules; in any event they are real costs that would
not otherwise be recovered."^{⁽¹⁴⁰⁾ As such their continued recovery, pending separations reform, is
necessary and should be recovered via bulk billing as described below.}}

The remainder of the TIC, about $15M for Pacific, is unspecified. We support recovery for it (in addition to the $40M described above) via bulk-billing of access customers based on revenues and/or minutes of use.^{⁽¹⁴¹⁾ Alternatively, if the Commission continues to use a productivity factor, we
support a productivity offset where the productivity factor could be targeted to the remaining TIC,
gradually eliminating it over a number of years.}

This approach is proper whether or not a market-based or prescriptive approach to reform is chosen. The TIC revenue requirement is real and proper. It is therefore necessary that a viable recovery mechanism be provided.

A. SS7 Signalling (¶¶ 123-134)

This Commission seeks comment on how SS7 signalling costs should be recovered. While we generally support the Ameritech structure referenced by the Commission, a strict rate structure should not be imposed upon the industry.^{⁽¹⁴²⁾ Companies should have the flexibility to design a
rate structure that best reflects the way SS7 technology is configured in that network.}

The Commission realizes that some LECs may not have the appropriate monitoring equipment to measure SS7 usage.^{⁽¹⁴³⁾ We are one of those LECs. Installing the necessary equipment
will cost millions of dollars. If the Commission mandates this expenditure for the measurement
capability, these costs need to be recovered through discrete rate elements. The Commission must treat
this service as a new service under the current rules and allow full cost recovery from all users.}

A. New Technologies (¶139)

As we stated earlier in Section VI C 2, the Commission should not adopt any uniform access charge rules for new services as a result of new emerging technologies, as strict uniform rules which do not allow for cost recovery may stifle their deployment. The Commission should allow flexibility to individual companies as to how they choose to structure or recover the cost of new services based on their own unique market conditions. The introduction of new services has historically been slowed or brought to a standstill due to the standard, one size fits all, Part 69 approach. Maximum flexibility should be the road map of the future. Furthermore, we expect new services resulting from new emerging technologies to accelerate; regulatory processes will never change as fast as technology does. Many new services will be highly competitive and offered from many different market players in a wide array of structures. These services should not be subject to any form of regulation. Allow the marketplace, not regulation, to determine how these services are structured and costs recovered.

I. REGULATION OF TERMINATING ACCESS SHOULD BE SYMMETRICAL BETWEEN INCUMBENT AND NON-INCUMBENT LECS (¶¶271-281)

The Notice asks whether competitive LECs terminating access services should be subject to different limits than incumbent price cap LECs terminating access service.^{⁽¹⁴⁴⁾ As the Notice
correctly notes the market factors affecting non-incumbent LECs terminating access services are the
same as for incumbent LECs: the called party selects the carrier that provides terminating access and
the calling party makes the decision to place the call.^{⁽¹⁴⁵⁾ Competitive LECs have the same incentives and
abilities regarding terminating prices as do incumbent LECs. There is no rational basis for
distinguishing between incumbent and non-incumbent LECs. Whatever regulation or market flexibility
is applied to non-incumbent LECs should apply as well to incumbent LECs.}}

I. THE COMMISSION MUST REMOVE UNREASONABLE DISCRIMINATION FAVORING ESPS IN ORDER TO CREATE PROPER INCENTIVES FOR NETWORK USE AND DEVELOPMENT AND TO COMPLY WITH THE ACT (¶¶ 282-290)

We recognize and appreciate that the Commission has started an NOI in CC Docket No. 96-263 on Usage of the Public Switched Network by Information Service and Internet Access Providers. We remain deeply concerned, however, that the current ESP exemption is plainly discriminatory and that market and economic conditions are exasperating the harmful effects of this discrimination on our business. The far better approach is for the Commission to end ESP discrimination at the same time that it reforms access. Our concern is heightened because this discriminatory treatment was always meant to be a temporary condition and should have been corrected years ago. Nonetheless the discrimination has continued for fourteen years, and there is no better time than now, as part of access reform, to end it. In this proceeding, the Commission should remove the ESP exemption at the same time that it addresses access charges for IXCs. To the extent that the Commission chooses to eliminate the discrimination through the NOI, however, it must act promptly in that proceeding.

The Commission cannot do anything about the past, other than correct misunderstandings, but it can encourage better solutions for the future. In its Notice, the Commission explains that "as part of this comprehensive proceeding, we must consider how our rules can provide incentives for investment and innovation in the underlying networks that support the Internet and other information services."^{⁽¹⁴⁶⁾ We agree that the Commission must consider these rule changes here, in this
proceeding, because this is where the Commission is determining the regulations that will govern the
interstate access networks that support information services. The current exemption for ESPs from
payment of interstate access charges (1) is discriminatory and grants a preference in rates to ESPs as
compared to other access users, (2) provides ESPs the strong incentive to use local business lines that
are inefficient for their types of traffic, (3) provides LECs with little incentive for investment and
innovation in more efficient services, and (4) does not allow cost recovery for expansion of the network
for use by ESPs.}

Unlike 1983 when the Commission created the ESP exemption to foster the development of a fledgling market, the Enhanced Services industry is now well developed and too large to be exempt from access charges. We estimate that currently ESPs generate 25% to 35% as much traffic as IXCs on Pacific Bells circuit switched network and that ESP traffic on Pacific Bell's circuit switched network will exceed 20 billion minutes in 1997. ESP traffic is growing dramatically faster than other traffic and, thus, is causing network capacity investments that otherwise would not be necessary.

Simply put, ESPs use more yet pay less than other network users. As explained below, this use is burdening the network and generating more costs for LECs that others are forced to pay. It would be difficult to find a clearer case of discrimination. It is well past the time when the discrimination should have ended, and the order in this proceeding is the proper vehicle to finally end it.

A. The Recent Selwyn/Laszlo Study Does Nothing To Explain Or Justify The Unlawful Discriminatory Treatment Afforded ESPs

The study that Lee Selwyn and Joseph Laszlo released January 22, 1997 on behalf of the Internet Access Coalition^{⁽¹⁴⁷⁾ -- apparently aimed at continuing the current discriminatory treatment for
ESPs -- contains fundamental flaws. We briefly describe some of those flaws in this section and provide
more details from Pacific Bells situation in the sections that follow.}

First, the study asserts that data traffic does not pose a significant threat to network integrity "at this time."^{⁽¹⁴⁸⁾ It attributes this network security to the nature of the network and Internet
traffic. Actually, the reason that network integrity is protected in Pacific Bells territory is that we are
dedicated to investing hundreds of millions of dollars over the next few years in network expansion to
handle enhanced services traffic. Incurring these costs is crucial to protect large numbers of telephone
service subscribers, and there is no reason to discriminate in favor of ESPs and exempt them from
having to pay for these costs.}

Second, the study asserts that the LECs sales of second lines to subscribers have produced additional LEC revenues that exceed the costs of accommodating Internet traffic.^{⁽¹⁴⁹⁾ Actually,
the costs of second lines used with Internet access exceed the flat rates that Pacific Bell receives for the
lines. Thus, to the extent these lines are used for Internet communications, they do not contribute to the
recovery of Pacific Bells investment that is needed to accommodate Internet traffic. If anything, they
simply create more costs caused by ESPs yet paid by others.}

Third, the study asserts that ESPs use the PSTN like business customers.^{⁽¹⁵⁰⁾ Actually,
unlike business customers, ESPs do not use local business lines to originate calls and, thus, do not pay
outbound usage charges. ESPs use the lines solely to receive calls from their subscribers, for which
Pacific Bell receives no usage revenues. Moreover, on average, ESPs data communications are
substantially greater in quantity and duration than the communications of business customers and, thus,
require more switch and interoffice network capacity, again increasing costs.}

Fourth, the study asserts that the "long term solution for accommodating increased data traffic lies in the stimulation of competition and in the deployment of appropriate data-friendly network technologies, and not in the imposition of per-minute 'access charges for use of the current voice-oriented circuit switched network."^{⁽¹⁵¹⁾ Actually, the deployment of data-friendly network technologies
is frustrated by the discriminatory exemption for one group of access users, the ESPs, from the charges
paid by other access users. Allowing ESPs to have virtually free use of the circuit switched network
gives them the strong incentive to continue to send all their traffic over that network rather than use
more efficient "data-friendly" services for which they would have to pay charges that recover the LECs
costs. It also forces others to pay for the costs ESPs are causing.}

A. Eliminating The ESP Exemption Will Remove Disincentives For Efficient Investment And Innovation In The Networks That Support Information Services (¶¶ 282-290)

The ESP exemption from access charges allows ESPs to use local business services instead of paying usage based charges for access to the public switched network. ESPs gain access to LEC loops and switches in order to offer services to end users, just like IXCs. One critical difference is that the current structure allows ESPs a lower, preferential rate which avoids the usage based charges that IXCs must pay for access.

Examination of Internet usage shows the added costs that ESPs cause. Internet access providers using Pacific Bells network have an average call duration approximately seven times greater than the average call duration for all Pacific Bells customers, and average peak-hour usage that is approximately five times greater.^{⁽¹⁵²⁾ Average Internet use is increased significantly by the 10% of
Internet users who remain on-line over six hours per day, and pay nothing more for doing so.}

According to the Selwyn/Laszlo Study, "the majority of ESP users fall into the range of 0 to 10 hours per month."^{⁽¹⁵³⁾ Accordingly, the effect on an "average" ESP end user's prices would be
an increase of $3.00 per month from applying a hypothetical usage rate of $.01 per minute to ESPs'
purchases of access, assuming a midpoint 5 hours per month use. This effect on ESP end-user prices
also assumes that the ESP passes on 100% of the usage based prices to the end users but does not pass
on any of the cost savings of moving to an access network architecture. By moving to that architecture,
ESPs could benefit from significant operational cost savings by eliminating the need for points of
presence in each local calling area. The ESP could pass on to its end users these cost savings, thereby
offsetting some of the price increase. A cost-based access regime will ascribe costs to the cost causers:
the 10% of ESP end users who account for "between 60% and 70% of total ESP hours of use."^{⁽¹⁵⁴⁾ This
approach would create sound economic and technical incentives for offering new data access services
for high volume users.}}

The effect of the unlawful discrimination favoring ESPs is made greater by the fact that some of the largest ESPs are also IXCs. The original value added network ("VAN") providers that the Commission benefited with the ESP exemption have been bought by, or merged with, IXCs (e.g., Sprint/Telenet, MCI/BT Tymnet). Sprint, for instance, buys Pacific Bells service, bundles its own service, and sells the package to AOL. Pacific's revenues from Sprint, based on flat rate business lines, do not cover the cost of providing service to Sprint and represent only a small fraction of the revenues that Sprint gets from AOL for the package.

AT&T has over 600,000 subscribers to its Internet access service.^{⁽¹⁵⁵⁾ Moreover, AT&T
is using this service primarily to protect its long distance business. It has offered five hours of Internet
access each month for a year at no charge to subscribers of AT&T long distance, and unlimited use at
$19.95 per month to subscribers of AT&T long distance, but at $24.95 per month for non-AT&T
subscribers.^{⁽¹⁵⁶⁾ What possible sense does it make for Pacific Bell to subsidize AT&T via the ESP
exemption, so that AT&T can subsidize its long distance business in order to protect against losses to
competitors. These effects of the ESP exemption are clearly contrary to the Commissions goals to
increase competition and benefit consumers.}}

The time is long past when the unlawful discrimination favoring ESPs should have ended. We cannot change the past, but we urge the Commission to allow better solutions for the future by removing the ESP exemption. The Notice misses the key point when it states, "The mere fact that providers of information services use incumbent LEC networks to receive calls from their customers does not mean that such providers should be subject to an interstate regulatory system designed for circuit-switched interexchange voice telephony."^{⁽¹⁵⁷⁾ So long as ESPs are provided strong financial
incentives via the ESP exemption to use the circuit-switched network, they will continue to use it in a
discriminatory manner that disadvantages LECs and other network users. LECs will continue to be
required to expand their networks to accommodate this unreimbursed use, rather than being able to
make greater investment in new network solutions. Funds could be much better spent to meet the
economically efficient and longer term needs of ESPs and their customers, if the Commission removes
the uneconomic incentives caused by the ESP exemption.}

A. The Commission Must Act Now To End Unreasonable Discrimination Favoring ESPs (¶¶282-290)

Any conclusion in this proceeding to support the current ESP exemption would be an endorsement of continued unreasonable discrimination in violation of Sections 201 and 202 of the Act. The D.C. Circuit upheld the ESP exemption in 1984 against charges that it created unreasonable discrimination because it was a "graduated transition" that caused only "slight rate disparities," not a permanent exemption that creates substantial disparities in payments. ^{⁽¹⁵⁸⁾ We are confident that the D.C.
Circuit would conclude differently now that the exemption (1) has been in place 13 more years without
any "graduated transition" to remove discrimination, (2) exempts ESPs, which have become part of a
huge industry and some of which are multi-billion dollar corporations, from payment of hundreds of
millions of dollars in charges that other customers pay every year, and (3) provides ESPs with the
incentive to use carriers networks inefficiently.}

The Commission has given the enhanced service market fourteen years to develop by exempting ESPs from the access structure. In 1983, the Commission adopted its access charge plan to establish the terms and conditions for interstate access "to remedy discrimination and preferences that violate Section 202(a) of the Communications Act."^{⁽¹⁵⁹⁾ The Commission did not create the ESP
exemption in order to lock in one form of disparate treatment. Rather, the exemption was to be a part
of a set of "transitional" rules designed to avoid "rate shock" by phasing-in access charges for
interexchange resellers and ESPs, two classes of providers who had depended on low-priced business
lines to obtain local access.^{⁽¹⁶⁰⁾ Although ordinary resellers soon lost their access charge exemption,^{⁽¹⁶¹⁾
ESPs maintained theirs. In response to ESP arguments that their's was an "infant industry," the
Commission initially reasoned that continuation of the exemption was justified by (1) the impending
introduction of ONA requirements, (2) the BOC ability to enter into the information services business
pursuant to the modification of the MFJ, and (3) the relatively fragile and volatile state of the enhanced
services industry.^{⁽¹⁶²⁾ Even after ONA was in place^{⁽¹⁶³⁾ and the BOCs had entered the information services
business, the Commission continued to justify the access charge exemption as appropriate to avoid
"disrupt[ing] the enhanced services industry during a time of rapid transition."^{⁽¹⁶⁴⁾ Rapid transition
appears to be a permanent way of life for our industry, and can not possibly be considered a reasonable
justification for continued discrimination.}}}}}}

In this proceeding, the Commission should remove the ESP exemption at the same time that it addresses access charges for IXCs. If, however, the Commission finds that removal of subsidies will take time, it could waive CCLC, TIC, and reserve deficiency amortization payments for ESPs. As a less beneficial interim alternative, the Commission could create an explicit subsidy to compensate LECs until the Commission removes the exemption.

It is essential that the Commission correct the problems caused by discriminatory pricing under the ESP exemption and at least take interim steps to achieve an equitable access structure in this proceeding. We believe that 14 years is more than long enough for a transitional period to bring ESPs into the access structure.

CONCLUSION

Access must be reformed. But, it must be reformed in a way that is consistent with the current state of competition, the existing separation rules, and the existing regulatory compact. The Commission does not need to prescribe rates, nor engage in activist administrative procedures. Instead the Commission needs to recognize that in areas facing competition, economics will set appropriate rules, and prices will be set that encourage efficiency. The Commission needs to take the leash off of our access prices and let competition work.

For the reasons given above, Pacific urges the Commission to adopt a market-based approach to access reform based on the USTA recommendations, modify the current access charge rate structure to more accurately reflect cost causation, implement mechanisms to assure that incumbent LECs will be able to recover all of their actual interstate costs, including embedded costs, and remove the ESP exemption.

Respectfully submitted,

PACIFIC TELESIS GROUP

MARLIN D. ARD

NANCY C. WOOLF

140 New Montgomery Street

San Francisco, California 94105

(415) 542-7657

MARGARET E. GARBER

1275 Pennsylvania Avenue, N.W.

Washington, D.C. 20004

(202) 383-6472

Its Attorneys

Date: January 29, 1997

Before the

FEDERAL COMMUNICATIONS COMMISSION

COMMENTS OF PACIFIC TELESIS GROUP

MARLIN D. ARD

NANCY C. WOOLF

140 New Montgomery Street

San Francisco, California 94105

(415) 542-7657

MARGARET E. GARBER

1275 Pennsylvania Avenue, N.W.

Washington, D.C. 20004

(202) 383-6472

Attorneys for Pacific Telesis Group

Date: January 29, 1997

SUMMARY

Reform of the existing access charge regime is necessary and required by the changes wrought by the Telecommunications Act of 1996. The goals of reform should be to--

- Eliminate unnecessary regulatory requirements,

- Introduce competition efficiently, and

- Assure that incumbent LECs are able to recover all of their costs, including all interstate separations, universal service, and current costs.

The Commission cannot lawfully impose rate regulation on access services that would not permit incumbent LECs to recover all of these costs.

Lower access prices will not necessarily make consumers better off.

- Consumers are already paying far more than they should for intrastate and interstate long distance services.

- The interexchange carriers typically do not pass access charge reductions on to consumers, but use the windfall to increase their profit margins.

- Artificial reductions in access charges will not help consumers; more competition in the interLATA market will.

It is not necessary to reduce access charges by regulation to prevent incumbent LECs from having an advantage in the long distance market.

- A price squeeze is impossible under current market conditions.

California is already competitive.

- Numerous facilities based competitive LECs have entered the California market.

- Access customers are demand elastic and have already switched substantial business to competitive providers.

_ Supply elasticity is also high; existing competitive capacity can already carry a substantial portion of all of Pacific Bells switched access traffic.

To determine the presence of competition, the Commission should consider specific services and realistic geographic areas.

- DS1 and higher, for example, should immediately be deregulated.

A market-based approach to access reform is the only approach consistent with the Act.

- Pacific supports the USTA proposal for a market-based reform process

- Phase I relief--a simplified price structure--should be triggered by showing a presence of competition through a state approved interconnection agreement or statement of generally available terms and conditions

- Phase I relief should include contract carriage and deregulation of new services

- Phase II relief--removal of price cap regulation--should be triggered by a demonstration of substantial competition on a service and geographic basis.

The Commission should not adopt a prescriptive approach to access reform

- Interstate access revenues cannot be lowered based on forward-looking cost principles, without compensation elsewhere

- Pricing access services based on forward looking costs will preclude recovery of actual costs and thus constitute an unconstitutional taking

- There are tremendous practical problems making the detailed cost studies necessary to prescribe access prices

- Reinitializing price cap indices would eliminate incentives for increasing efficiency

Retaining the Carrier Common Line charge will not cause a double recovery of universal service support.

A downward exogenous cost adjustment should be made to reflect net universal service revenues to the carrier and an exogenous cost increase should be allowed if a carriers contributions that cannot be directly passed through to consumers exceed revenues from the fund.

Any transition mechanism must provide for the recovery of all LEC current costs

- Recovery of capital depreciation reserve deficiency and any underdepreciation should be accomplished via a 5 year amortization

IXCs should be required to pay their fair share of LEC costs if they use unbundled elements as a substitute for access service

The existing access rate structure should be modified

- CCLC should be reduced or eliminated by increasing the SLC caps or by allowing the multi-line SLC to increase to its $6.00 cap

- Any residual CCLC should be bulk billed on a presubscribed line basis

- Local switching should include a flat-rated line and trunk port charge, a per message set up charge, and a per minute usage charge

- Dedicated facilities for transport should be flat-rated

- Portions of the TIC should be reallocated into other appropriate rate elements

- The remainder of the TIC should be bulk billed to access customers based on interstate revenues

The regulatory treatment of terminating access service should be the same for incumbent LECs and non-incumbent LECs

The exemption for enhanced service providers should be removed in the same order that reforms access charges

TABLE OF CONTENTS

PAGE

SUMMARY ............................................................................................................................................vi

I. INTRODUCTION 1

II. EVEN WIDESCALE DECREASES IN ACCESS PRICES ARE UNLIKELY TO RESULT IN LOWER PRICES TO THE CONSUMER; REDUCTIONS IN ACCESS PRICES SHOULD NOT OCCUR IN ANY STATE UNTIL BOC INTERLATA ENTRY HAS BEEN APPROVED (¶ 41) 6

III. ACCESS PRICES BASED ON FORWARD LOOKING COSTS ARE NOT A NECESSARY PRECONDITION TO A COMPETITIVE LONG DISTANCE MARKET; MOREOVER, NO REASON EXISTS WHY ACCESS CHARGES SHOULD NOT APPLY TO UNBUNDLED ELEMENTS (¶¶ 47, 148) 9

IV. SUBSTANTIAL COMPETITION ALREADY EXISTS IN CALIFORNIA; THE PRESENCE OF COMPETITIVE ALTERNATIVES SHOULD BE THE PREDICATE UPON WHICH MARKET-BASED TRIGGERS ARE BASED (¶¶ 140-155) 12

V. THE COMPETITIVE FACTORS THE COMMISSION PROPOSES TO USE TO DETERMINE THE PRESENCE OF SUBSTANTIAL COMPETITION ARE NOT ECONOMICALLY RATIONAL. (¶¶ 156-160, 203-210) 15

VI. THE COMMISSION SHOULD ENCOURAGE A MARKET-BASED APPROACH TO ACCESS PRICING WHICH BENEFITS CONSUMERS AND ADVANCES COMPETITION; IT WILL NOT GET THESE RESULTS WITH RESTRICTIVE TRIGGERS OR A MAZE OF COMPLEX PRICE CAP RULES WHICH BLOCK OR FRUSTRATE LEC PRICING FLEXIBILITY; MOREOVER, CREATING ARTIFICIAL PRICING DISTINCTIONS FOR LIKE SERVICES (UNBUNDLED ELEMENTS AND ACCESS CHARGES) WILL KILL OFF INVESTMENT VITALLY NEEDED TO ACCOMPLISH FUNDAMENTAL ACT OBJECTIVES (¶¶ 161-217) 17

A. Summary of Pacifics Proposal for Market-Based Triggers, Price Cap Reform, and the Pricing of Access Charges and Unbundled Elements 17

B. Phase I Should Be Triggered By An Approved Interconnection Agreement Or Statement Of Generally Available Terms and Conditions. (¶¶ 168-179) 19

C. Phase I Relief Permits Pricing Flexibility (¶¶ 168-200) 20

1. Contract Carriage Would Substantially Benefit Customers In Many Access Markets (¶¶ 193-196) 20

2. New Services Should Not Be Subject To Onerous Requirements Such As Part 69 Waivers Or Public Interest Tests (¶¶197-200) 23

3. Geographic Deaveraging Must Be Authorized To Reflect Variations In Costs (¶¶ 180-186) 25

4. Term And Volume Discounts (¶¶ 187-192) 26

D. Phase II Should Remove Services From Price Cap Regulation When Competition Is Demonstrated In The Area (¶¶ 201-217) 26

1. Substantial Competition Should Be Established By Service And On a Geographic Basis. (¶¶ 202-210) 26

E. The Commission Should Forbear From Regulating DS1 And Higher Special Access Services Since They Face Substantial Competition (¶ 153) 27

VII. THE FCC SHOULD NOT ADOPT THE PRESCRIPTIVE APPROACH TO ACCESS PRICING (¶¶218-240) 28

A. The FCC May Not Lawfully Implement The Prescriptive Approach To Access Reform Described In The Notice (¶¶218-240) 31

1. Access Charges May Not Be Reduced Prior To Separations Reform (¶¶218-240) 31

2. Proxy Models Should Not Be Used For Pricing 32

a) Cost Studies Are Already Available To Price Access 33

b) There Is No Need To Disaggregate Access Prices To Small Geographic Units 33

c) The Existing Models Do Not Contain Adequate Data for Access Pricing 34

d) Models Should Only Be Used To Estimate A Subsidy, Not Total Compensation 35

3. Use Of TSLRIC To Reprice Access Services, Reinitialize Price Cap Indices, Or Justify Above-Cap Filings Would Effect Unconstitutional Takings (¶¶223-238) 36

B. Practical Implementation Difficulties Will Doom Any Prescriptive Approach (¶¶218-240) 37

C. The FCCs Other Proposals For Modification Of The Existing Price Cap Regime Also Should Not Be Adopted (¶¶231-235) 39

1. In A Competitive Environment, No Productivity ("X") Factor Is Necessary (¶¶ 231-235) 40

2. Alternatively, Productivity Could Be Set Equal To The GDPPI Inflation Factor (¶¶ 231-235) 41

3. Sharing Should Be Eliminated From The Price Cap Plan 43

4. There Is No Basis to Reinitialize Price Cap Indices Based for a New Rate of Return Prescription 43

VIII. LECS ARE ENTITLED TO FULL COST RECOVERY OF CURRENT COSTS AND CAPITAL DEPRECIATION RESERVE DEFICIENCY AMOUNTS (¶¶ 241-270) 44

A. Recovery Of All Costs Is Compelled By The Communications Act And Is Necessary To Avoid An Unconstitutional Taking Of ILECs Property (¶¶247-260) 44

B. The Capital Reserve Deficiency Is Substantial And Must Be Recovered (¶¶249-255, 266-270) 46

C. The FCC's "Market-Based" Transitional Mechanism Will Not Permit ILECs to Recover All Remaining Costs (¶¶260-270) 47

D. Universal Service Support Will Not Amount To Double Recovery For Access Charges (¶¶242-246) 49

E. Future InterLATA revenues cannot recover embedded costs (¶256) 50

IX. CARRIERS SHOULD NOT BE ALLOWED TO ENGAGE IN UNECONOMIC ARBITRAGE UNDER THE COMMISSIONS RULES AND AVOID PAYING THEIR FAIR SHARE OF UNIVERSAL SERVICE OBLIGATIONS BY USING UNBUNDLED ELEMENTS TO PROVIDE EXCHANGE ACCESS SERVICES (¶54) 52

A. The Current Access Charge Rules Include Actual Costs As Well As Several Subsidies In Access Rates To Support Below-Cost Residential Telephone Service Rates (¶54) 53

B. Permitting Carriers To Avoid Access Charges By Purchasing Unbundled Elements Will Allow Them To Avoid Contributing Their Fair Share To The Provision Of Low Cost Residential Service While Preventing ILECs From Recovering Their Costs And Competing In The Exchange Access Market (¶54) 55

C. Until Such Time As Access Charges Are Priced Consistently With Unbundled Network Elements, Carriers Using Unbundled Elements To Obtain Exchange Access Service Should Be Required To Pay The Difference Between The Cost Of The Unbundled Network Elements And The Access Charges They Would Be Required To Pay If They Purchased Such Services Directly From The ILEC (¶54) 57

X. RATE STRUCTURE MODIFICATION 58

A. Common Line Costs Should To The Extent Possible Be Charged To End Users And Should Be Permitted to be Deaveraged (¶¶ 57-70) 59

1. The Subscriber Line Charge ("SLC") Rate Structure Should Be Modified and Geographically Deaveraged (¶¶57-67) 61

2. Any Residual Carrier Common Line Charge ("CCLC") Should Be Recovered On A Flat-Rated Basis (¶¶ 59-63) 64

3. SLCs On ISDN And Derived Channels (¶¶ 68-70) 64

B. Local Switching Costs Should Be Recovered In The Way They Are Incurred (¶¶ 71-79) 66

C. Transport Rates Should Be Structured To Reflect The Way Transport Costs Are Incurred, And Restructured So That Amounts In The TIC Are Reclassified To More Appropriate Rate Elements (¶¶ 80-122) 69

D. SS7 Signalling (¶¶ 123-134) 73

E. New Technologies (¶139) 73

XI. REGULATION OF TERMINATING ACCESS SHOULD BE SYMMETRICAL BETWEEN INCUMBENT AND NON-INCUMBENT LECS (¶¶271-281) 74

XII. THE COMMISSION MUST REMOVE UNREASONABLE DISCRIMINATION FAVORING ESPS IN ORDER TO CREATE PROPER INCENTIVES FOR NETWORK USE AND DEVELOPMENT AND TO COMPLY WITH THE ACT (¶¶ 282-290) 74

A. The Recent Selwyn/Laszlo Study Does Nothing To Explain Or Justify The Unlawful Discriminatory Treatment Afforded ESPs 76

B. Eliminating The ESP Exemption Will Remove Disincentives For Efficient Investment And Innovation In The Networks That Support Information Services (¶¶ 282-290) 78

C. The Commission Must Act Now To End Unreasonable Discrimination Favoring ESPs (¶¶282-290) 80

XIII. CONCLUSION 83

1. ¹ Notice ¶ 5.

2. ² Id.

3. ³ Notice ¶ 1.

4. ⁴ Notice ¶ 248.

5. ⁵ See Notice ¶ 23.

6. ⁶ In addition, LECs carry depreciation reserves on their books, which are not recovered by current access revenues.

7. ⁷ Notice ¶ 49.

8. ⁸ Notice ¶ 6.

9. ⁹ See, e.g., FPC v. Hope Natural Gas Co., 320 U.S. 591, 603 (1944)

10. ¹⁰ Federal-State Joint Board on Universal Service, CC Docket No. 96-45.

11. ¹¹ Notice ¶ 18.

12. ¹² Id.

13. ¹³ Implementation of the Local Competition Provisions of the Telecommunications Act of 1996, CC Docket No. 96-98, First Report and Order, 11 FCC Rcd 15499 (1996), Order on Reconsideration, CC Docket No. 96-98, 11 FCC Rcd 13042 (1996), petition for review pending and partial stay granted, sub nom. Iowa Utilities Board et. al v. FCC, No. 96-3321 and consolidated cases (8th Cir., Oct. 15, 1996), partial stay lifted in part, Iowa Utilities Board et. al v. FCC, No. 96-3321 and consolidated cases (8th Cir. Nov. 1, 1996) ("Local Competition Order").

14. ¹⁴ "Rates Increased 5.9% by AT&T, Its Biggest Rise in Nearly 3 Years," New York Times, page D1 (November 28, 1996).

15. ¹⁵ Notice, ¶¶ 47, 148.

16. ¹⁶ Emmerson, p. 20.

17. ¹⁷ Id. p. 21.

18. ¹⁸ Schmalensee & Taylor, attached to USTA Comments, p. 24.

19. ¹⁹ Id. p. 34.

20. ²⁰ Quality Strategies 3Q96 Hicap track study.

21. ²¹ Quality Strategies, 3Q96 Switched MOU study.

22. ²² See discussion at Section VI E, seeking forbearance from regulation of these competitive services.

23. ²³ Order Instituting Rulemaking on the Commission's Own Motion into Competition for Local Exchange Service, R. 95-04-043, D. 96-09-087, September 1996.

24. ²⁴ AT&T is Venturing Cautiously into Local Telephone Business, N.Y. Times, January 28, 1997 at D1.

25. ²⁵ Notice ¶¶ 156-160.

26. ²⁶ The Commissions proposed Phase II trigger also includes a discussion of absolute measures of competitors presence in an area.

27. ²⁷ Emmerson, p. 12.

28. ²⁸ William M. Landes and Richard A. Posner, Market Power in Antitrust Cases, Harvard Law Review, Vol. 94 (March 1981) pp. 975-976.

29. ²⁹ In the Matter of Telecommunications Access Provider Survey, CCB-IAD 95-110, Comments of Pacific Bell and Nevada Bell, filed December 11, 1995.

30. ³⁰ The Commission has issued rules "to prohibit anticompetitive discrimination and cost-shifting, while still giving consumers the benefit of competition" (Implementation of the Non-Accounting Safeguards of Section 271 and 272 of the Communications Act of 1934, as amended, CC Docket No. 96-149, First Report and Order and Further Notice of Proposed Rulemaking, released December 24, 1996.) and to "protect regulated service ratepayers from bearing the risks and costs of carriers nonregulated ventures" (Accounting Safeguards Under the Telecommunications Act of 1996, CC Docket No. 96-150, Report and Order, released December 24, 1996.)

31. ³¹ Emmerson, p. 10.

32. ³² Emmerson, p. 16.

33. ³³ Notice ¶ 177.

34. ³⁴ We do not discuss this reform in these comments. We support the concept as outlined by USTA in its comments.

35. ³⁵ We have attached to these Comments an ex parte dated November 15, 1996 setting forth in detail the legal precedent for contract carriage and why contract carriage is in the public interest.

36. ³⁶ See Arkansas Louisiana Gas Co. v. Hall, 453 U.S. 571, 582 (1981); American Broadcasting Companies, Inc. v. FCC, 643 F.2d 818 (D.C. Cir. 1980).

37. ³⁷ RCA American Communications, Inc., 84 FCC 2d 353, 358 (1980).

38. ³⁸ 10 FCC Rcd at 4572-4574, ¶¶ 23-25.

39. ³⁹ Id.

40. ⁴⁰ Id.

41. ⁴¹ There is an argument that the prohibition of unreasonable practices in Section 201(b) of the Act cannot be invoked to limit the rights of a carrier to modify a tariff unilaterally. Although this argument seems attractive at first blush, scrutiny reveals that, in practice, it goes too far. It is well-established that tariff revisions by a carrier can be rejected if the Commission finds that any of the proposed terms are patently unlawful. See Maine Public Advocate v. FCC, 828 F.2d 68 (1st Cir. 1987). The Commission also can suspend and ultimately prevent a tariff from taking effect based on a finding that a term is unlawful as an unreasonable practice under Section 201(b) of the Act. See Capital Network Systems, Inc. v. FCC, 28 F.3d 201 (D.C. Cir. 1994). Thus, while one might argue that the mere unilateral filing by a carrier of a revision to a tariff is permitted under Section 203, the revision can nonetheless be rejected as unlawful and prevented from taking effect. The consequences to the customer are the same under either legal theory.

42. ⁴² In re Alternative Regulatory Frameworks for Local Exchange Carriers, 1994 Cal. PUC. LEXIS 681.

43. ⁴³ Notice ¶ 199.

44. ⁴⁴ Notice ¶ 199.

45. ⁴⁵ 47 U.S.C. 157(a).

46. ⁴⁶ Notice ¶ 182.

47. ⁴⁷ Local Competition Order ¶ 764.

48. ⁴⁸ 47 USC 160(a).

49. ⁴⁹ See Notice ¶ 149.

50. ⁵⁰ See Notice ¶ 142

51. ⁵¹ Notice ¶¶ 222, 224.

52. ⁵² Notice ¶¶ 229-235.

53. ⁵³ See Notice ¶¶ 218, 220.

54. ⁵⁴ See Notice ¶ 6.

55. ⁵⁵ Comments of Pacific Telesis Group, CC Docket No. 96-45 (filed December 19, 1996).

56. ⁵⁶ See, e.g., In the Matter of Policy and Rules Concerning Rates for Dominant Carriers, 4 FCC Rcd 6786, 6816 (1990).

57. ⁵⁷ Emmerson, pp. 23-24.

58. ⁵⁸ Notice ¶ 6.

59. ⁵⁹ See, 47 C.F.R. Part 36. "Costs" are defined in Part 36 as the "cost of property owned by the Telephone Company. . . ." 47 C.F.R. Part 36 (Appendix). This definition cannot be satisfied by reference to the hypothetical, forward-looking costs of some imaginary entity.

60. ⁶⁰ See 47 U.S.C. § 410(c). Cf. New York Tel. Co. v. FCC, 631 F.2d 1059 (2d Cir. 1980).

61. ⁶¹ See 47 U.S.C. § 201.

62. ⁶² The shortfall between the allocation of separated costs and a deficient Commission-prescribed access cost recovery based on TSLRIC or TELRIC would also dramatically illustrate the unconstitutionality of such a prescription.

63. ⁶³ Emmerson, p. 25.

64. ⁶⁴ Emmerson, p. 23.

65. ⁶⁵ Emmerson, p. 24.

66. ⁶⁶ Id..

67. ⁶⁷ Id.

68. ⁶⁸ Emmerson, p. 26.

69. ⁶⁹ Duquesne Light Company v. Barasch, 488 U.S. 299, 310 (1989) (quoting FTC v. Hope Natural Gas Company, 320 U.S. 591, 605 (1944)).

70. ⁷⁰ Hope, 320 U.S. at 603.

71. ⁷¹ The inclusion of an allocation of joint and common costs would not be sufficient to cure the constitutional infirmity of such a prescription.

72. ⁷² In the Matter of Policy and Rules Concerning Rates for Dominant Carriers, 3 FCC Rcd 3195, 3323-3331 (1988); 4 FCC Rcd at 6816.

73. ⁷³ Id., 3 FCC Rcd at 3323-24.

74. ⁷⁴ Greater Boston Television Corp. v. FCC, 44 F.2d 841 (D.C. Cir. 1970).

75. ⁷⁵ Notice ¶ 224.

76. ⁷⁶ The California PUC has completed a TSLRIC cost study of Pacific's services, and is currently evaluating additional costs studies. But other states may not have embarked on such analyses.

77. ⁷⁷ Notice ¶¶ 228, 233.

78. ⁷⁸ In eliminating the GDPPI -X formula at the state, the CPUC found that "Since Pacific has already become highly efficient, additional efficiencies will be more difficult to achieve." Investigation on the Commissions Own Motion into the Second Triennial Review of the Operations and Safeguards of the Incentive-Based Regulatory Framework for Local Exchange Carriers, D. 95-12-052, 1995 Cal. PUC LEXIS 1015.

79. ⁷⁹ Christensen Attachment 5 to USTA Comments, pp. 7-9.

80. ⁸⁰ LEC Price Cap Performance Review, CC Docket 94-1, First Report and Order, released April 7, 1995.

81. ⁸¹ DA 96-139 (Released February 6, 1996).

82. ⁸² Notice ¶ 228.

83. ⁸³ Notice ¶ 256.

84. ⁸⁴ 47 U.S.C. § 201(b).

85. ⁸⁵ See Duquesne Light Co. v. Barasch, 488 U.S. 299, 310 (1989); FPC v. Hope Natural Gas Co., 320 U.S. 591, 605 (1944).

86. ⁸⁶ Sidak & Spulber, attached to Comments of USTA

87. ⁸⁷ Notice ¶ 251-253.

88. ⁸⁸ Notice ¶ 260.

89. ⁸⁹ Notice ¶¶ 261-265.

90. ⁹⁰ Notice ¶ 261.

91. ⁹¹ Id.

92. ⁹² See Section IV, supra.

93. ⁹³ Notice ¶ 245.

94. ⁹⁴ Notice ¶ 244.

95. ⁹⁵ The Joint Board incorrectly recommended that the benchmark be set at the nationwide average revenue per line, which includes revenues generated by discretionary services (such as call waiting, caller ID, and others) and access services. See Comments of Pacific Telesis Group filed in Universal Service Docket, CC Docket No. 96-45, filed on December 19, 1996.

96. ⁹⁶ 47 U.S.C. §227(e)(4).

97. ⁹⁷ Implementation of the Non-Accounting Safeguards of Sections 271 and 272 of the Communications Act of 1934, CC Docket No. 96-149 (First Report and Order and FNPRM) (Dec. 24, 1996) ¶¶ 259-267.

98. ⁹⁸ Notice ¶ 54.

99. ⁹⁹ Iowa Utilities Board v. F.C.C., Nos. 96-3321, et al. (8^th Cir., Jan. 6, 1997)

100. ¹⁰⁰ In the Matter of the Petition of AT&T Communications, Inc. for Arbitration Pursuant to Section 252(b) of the Telecommunications Act of 1996 to Establish an Interconnection Agreement with Pacific Bell, D.96-12-034, at 19-20 (December 9, 1996), appeal docketed, AT&T Communications of California, Inc., v. Pacific Bell (N.D.Cal. January 8, 1997).

101. ¹⁰¹ Local Competition Order, ¶ 719.

102. ¹⁰² In the Matter of American Telephone & Telegraph Company, Long Lines Department, 61 F.C.C.2d 587, 588 (1976).

103. ¹⁰³ Notice ¶¶ 27, 36-40.

104. ¹⁰⁴ Federal-State Joint Board on Universal Service, CC Docket No. 96-45, at ¶¶ 187-190 (rel. Nov. 8., 1996).

105. ¹⁰⁵ 47 C.F.R. Part 36.631.

106. ¹⁰⁶ In the Eighth Circuit appeal of the Commissions Local Competition Order, several state commissions claim that interstate traffic is still only 8 percent of the total traffic. Joint Reply Brief for the State Commission Parties at 2, Iowa Utilities Board v. F.C.C., Nos. 96-3321, et al. (8^th Cir., Jan. 6, 1997).

107. ¹⁰⁷ Local Competition Order, ¶¶ 704-707. This portion of the Commissions decision has been stayed by the Eighth Circuit. Iowa Utilities Board v. FCC, No. 96-3321, (8th Cir., Oct. 15, 1996).

108. ¹⁰⁸ Decisions such as that of the CPUC to apply access charges to unbundled elements used for toll calling may only temporarily ameliorate this effect. Interconnection Agreement Between AT&T of California, Inc. and Pacific Bell, Att. 18 (filed Dec. 19, 1996). However, Pacific Bell's ability to rely on this decision is subject to the outcome of the Eighth Circuit appeal, AT&T's appeal of the CPUC's approval of this requirement of its interconnection agreement with Pacific Bell, and, potentially, the further actions of this Commission.

109. ¹⁰⁹ Notice ¶ 42. Facilities-based alternatives to ILEC access services are already available and can be expected to proliferate, as the cost declines. For example, MCI has indicated that a single switch can already provide access services to an area within a 150 mile radius. Testimony of Drew Caplan in CPUC Dockets R. 93-04-003 & I. 93-04-002, Open Access and Network Architecture Development (OANAD) at 594 (July 18, 1996)]

110. ¹¹⁰ Notice ¶ 9.

111. ¹¹¹ Local Competition Order, ¶ 707.

112. ¹¹² Address of Reed Hundt, Chairman, FCC, to Fall Business Conference, Competitive Telecommunications Association, October 10, 1995.

113. ¹¹³ If the SLC were tied to the inflation rate the current residential and single line SLC charge would be approximately $4.25.

114. ¹¹⁴ Pacific Bells current rate for one party flat rate residential service is $11.25, among the lowest in the nation.

115. ¹¹⁵ See J. Hausman, T. Tardiff, and A. Belinfante, The Effects of the Breakup of AT&T on Telephone Penetration in the U.S., American Economic Review (1993).

116. ¹¹⁶ Home Office Market Forecast, 1995-2000, prepared by IDC/Link #11439, July 1996.

117. ¹¹⁷ Notice ¶ 67.

118. ¹¹⁸ Emmerson, pp. 3-4.

119. ¹¹⁹ Joint Board Recommendation ¶ 775.

120. ¹²⁰ The Joint Board found this a promising alternative. Id.

121. ¹²¹ Of course the CCL would be completely eliminated with the proposal set forth in section 1, above.

122. ¹²² Notice ¶ 70.

123. ¹²³ Notice ¶ 70.

124. ¹²⁴ Chairman Reed Hundt, "Media & Communications '96 Conference" September 17, 1996 "Competition: Walking the Walk and Talking the Talk"

125. ¹²⁵ In section C (1) below, we note that those portions of the TIC that are readily identifiable as properly assignable to another rate element, should be reassigned to that element. That reassignment includes the $25M attributable to analog end office trunk ports.

126. ¹²⁶ Like the trunk ports to which they connect, common transport facilities are by definition shared, and their costs must be recovered on a usage sensitive basis.

127. ¹²⁷ Notice ¶ 73.

128. ¹²⁸ Emmerson, pp. 8-9.

129. ¹²⁹ Schedule CAL. P.U.C. No. 175-T, Section 6.8.3.

130. ¹³⁰ Notice ¶ 76.

131. ¹³¹ Section 69.2 of the Commission's Rules (47 C.F.R. §69.2) defines Access Minutes or Access Minutes of Use. "On the originating end of an interstate or foreign call, usage is to be measured from the time the originating end users call is delivered by the telephone company and acknowledged as received by the interexchange carriers facilities connected with the originating exchange. On the terminating end of an interstate or foreign call, usage is to be measured from the time the call is received by the end user in the terminating exchange.

132. ¹³² Instead, a party must file a petition showing that the new service is in the public interest. Third Report and Order, ¶ 309.

133. ¹³³ Notice ¶ 86.

134. ¹³⁴ Schedule CAL. P.U.C. No. 175-T, Section 6.8.2.

135. ¹³⁵ See note 100.

136. ¹³⁶ Notice ¶ 90.

137. ¹³⁷ Emmerson, p. 9.

138. ¹³⁸ Comptel v. FCC, 87 F.3d 522, 532 (D.C. Cir. 1996).

139. ¹³⁹ See USTA Comments for further explanation of these items.

140. ¹⁴⁰ Comptel at 530.

141. ¹⁴¹ We do not support a bulk billing based on presubscribed lines for these amounts. The costs are not loop related and there is no reason to burden the local loop with these costs.

142. ¹⁴² In addition, the Notice omits three elements contained in the Ameritech waiver: (1) signal formulation charge; (2) signal tandem switching charge, and; (3) optional parameters charge.

143. ¹⁴³ Notice ¶ 137.

144. ¹⁴⁴ Notice ¶ 280.

145. ¹⁴⁵ Notice ¶ 279.

146. ¹⁴⁶ Notice ¶ 283.

147. ¹⁴⁷ Lee L. Selwyn, Joseph W. Laszlo, "The Effect Of Internet Use On the Nations Telephone Network," January 22, 1997 ("Selwyn/Laszlo Study").

148. ¹⁴⁸ Id. at v. See also id. at 3-4.

149. ¹⁴⁹ Id. at v., 21, 23-28, 36-37.

150. ¹⁵⁰ Id. at 17-18.

151. ¹⁵¹ Id. at v. See also id. at 52.

152. ¹⁵² See Letter from Alan Ciamporcero, Pacific Telesis, to Jim Schlicting, FCC, June 28, 1996.

153. ¹⁵³ Selwyn/Laszlo Study, p. 26.

154. ¹⁵⁴ Id.

155. ¹⁵⁵ Jon Swartz, "Troubles Increasing For AOL Another Breakdown, As State Prosecutors Consider Complaints," San Francisco Chronicle, January 24, 1997.

156. ¹⁵⁶ "AT&T Targets Masses With Free Access," Multimedia Week, March 4, 1996.

157. ¹⁵⁷ Notice ¶ 288.

158. ¹⁵⁸ NARUC v. FCC, 737 F.2d 1095, 1137 (D.C. Cir. 1984).

159. ¹⁵⁹ MTS and WATS Market Structure, CC Docket No. 78-72, Phase I, Third Report and Order, 93 FCC 2d 241, 265 (1983) ("Access Order"), modified on reconsideration, 97 FCC 2d 834 (1984) ("Access Reconsideration Order"), aff'd in principal part and remanded in part, National Ass'n of Regulatory Util. Comm'rs v. FCC, 737 F.2d 1095, 1137 (D.C. Cir. 1984), cert. denied, 469 U.S. 1227 (1985), 110 FCC 2d 1222 (1985), further reconsideration denied, 102 FCC 2d 849 (1985).

160. ¹⁶⁰ See Amendments of Part 69 of the Commission's Rules Relating to Enhanced Service Providers, CC Docket No. 87-215, Notice of Proposed Rule Making, 2 FCC Rcd 4305 (1987) ("ESP Exemption NPRM").

161. ¹⁶¹ See ESP Exemption NPRM, p. 4305.

162. ¹⁶² Amendments of Part 69 of the Commission's Rules Relating to Enhanced Service Providers, CC Docket No. 87-215, Order, 3 FCC Rcd 2631 (1988).

163. ¹⁶³ Because of the ESP exemption, ESPs purchase few interstate ONA services, preferring the lower priced intrastate services that they can purchase under exchange tariffs.

164. ¹⁶⁴ Amendments of Section 64.702 of the Commission's Rules relating to the Creation of Access Charge Subelements for Open Network Architecture, CC Docket No. 87-313, Report and Order, 6 FCC Rcd 4524, 4535, ¶ 60 (1991).

Geographic Area	Number of Competitive Fiber Networks	Number of Collocation Cages	Number of Cross-Connects
Wirecenter₍₁₎
Wirecenter₍₂₎
Wirecenter_(n)

				Services	Offered By	CLCs
Geographic Area	Local Inter- connection Trunks	Local Usage Exchanged (MOU per mo.)	Number of NXX Codes Opened by CLCs	CLC local switching (Y/N)	Resale lines in service (Y/N)	Unbundled loops in service (Y/N)
Wirecenter₍₁₎
Wirecenter₍₂₎
Wirecenter_(n)