Testimony before the Pennsylvania Senate Consumer Protection and Professional Licensure Committee
Telecommunications Deregulation -- Implementation of Chapter 30 of the Public Utility Code
April 25, 1996
CHAIRMAN BELL AND MEMBERS OF THE SENATE COMMITTEE ON CONSUMER PROTECTION AND PROFESSIONAL LICENSURE:
Thank you for the opportunity to testify before your Committee on the important issue of telecommunications deregulation in Pennsylvania and its impact on consumers.
This hearing is particularly timely in light of the recent enactment of landmark federal telecommunications legislation and in light of the ongoing litigation and regulatory proceedings that are currently before the Pennsylvania Public Utility Commission.
When the General Assembly examined these issues in 1993, I think it is fair to say that the critical concerns were alternative regulation for monopoly telephone companies and the deployment by those companies of a modern telecommunications network throughout urban, suburban, and rural Pennsylvania. Indeed, the final version of the Act, which became known as Chapter 30 of the Public Utility Code, was essentially a quid pro quo in which the incumbent monopoly telephone company agreed to deploy a broadband network throughout its service territory by the year 2015, in return for the promise of lessened regulation for non-competitive services and deregulation of competitive services. The argument went that the incumbent telephone companies needed freedom from cost-based regulation in order to give them the incentive to operate efficiently and to build a modern broadband network in hard-to-reach locations, particularly in rural Pennsylvania.
Bell Atlantic-Pennsylvania filed the first Chapter 30 proceeding in October 1993, and the Commission issued its decision in June 1994. In that June 1994 Order the Commission, by a vote of 4-1, approved Bell's proposal to deregulate the rates for six services which were found to be competitive, and to establish rates for all non-competitive services on the basis of an inflation index, without regard to profits or costs. The Commission modified Bell's index from "inflation minus 2.25%" to "inflation minus 2.93%." The Commission also required Bell to modify its network deployment plan to accelerate deployment from Bell's original proposal, particularly in rural areas. Finally, the Commission included a paragraph in its Order which stated: "That Bell's rates for protected services are, hereby, frozen until December 31, 1999."
In defending that Order in a Statement issued at that time, Commissioner John Hanger wrote: "The majority's opinion substantially modifies Bell's Petition. It freezes basic phone rates until the end of the century or December 31, 1999." Then-Chairman David Rolka, who also voted for the Order, issued a Statement, noting that "No rate increases for protected services are absolutely assured given the Commission's rate freeze on such services through the end of 1999."
In 1993 and 1994, our Office argued that freezing rates at existing levels was not a good deal for consumers; we argued that as the cost of providing telephone service declined and the revenues from new and existing services increased, rates for existing monopoly services ought to be reduced rather than frozen. While I still think that this position was correct as a matter of ratemaking principle, I now think that Commissioners Hanger and Rolka came to a reasonable practical conclusion that the most critical regulatory protection for basic residential service customers at that time was to at least ensure that the rates for those services couldn't go up. That is, if Bell was to be set free from all profit regulation as it entered a new and expanding world of telecommunications services, it was essential that basic residential service -- which is classified as a "protected" service under Chapter 30 -- actually be protected.
One reason that a firm cap on basic service rates was important in 1994, and is even more important now, is that for the first time, we at least have the possibility of competition in local telephone service. To the extent that competition can force Bell to lower rates in those areas and for those services where competition is likely to occur, then ratepayers who have competitive alternatives are likely to benefit. But that benefit will be meaningless from the perspective of Pennsylvania ratepayers as a whole if Bell is allowed to make up for any rate reductions by increasing rates dollar for dollar for those services and in those areas where competition has not yet and may not soon occur. Indeed, this so-called "rate rebalancing" has the dual impact of harming ratepayers, by raising rates in areas which lack competitive alternatives, and stifling competition in those areas where potential competitors are most likely to appear.
Do I believe that rates should be lowered in Philadelphia and Pittsburgh and other urban centers? Yes, absolutely, but those reductions should not be financed through rate increases to basic service charges in Coudersport and Bradford and Catawissa. Here's where I think the massive profits that Bell Atlantic is earning as a result of state and federal deregulation should come into play. Let's look at Bell Atlantic's own numbers and their own view of how those numbers will grow in the future.
In a press release dated January 23, 1996, Bell Atlantic announced "record earnings growth in 1995." Bell Atlantic reported net income of $1.86 billion in 1995 as well as a 2.9% increase in network revenues, a 3.4% increase in the number of access lines, a 4.9% reduction in work force, a 9.9% increase in access lines per employee, and a 2.4% reduction in cash operating expenses per access line.
But these 1995 results are just the beginning. In a speech given on March 19, 1996, before a Merrill Lynch Telecommunications Conference in New York, Bell Atlantic Chairman Ray Smith provided a look at his Company's earnings prospects in the near future. Chairman Smith predicted five percent revenue growth in 1996 and beyond and, he noted, "this is before contributions from our new long distance and video businesses, which will kick in in the 1997-98 time frame." He said a tremendous source of growth will be "second" lines in many homes, which increased by more than 50 percent in 1995. Chairman Smith noted: "Unlike traditional horizontal line growth, which would have significantly added to our capital expenditures, the vertical growth we experienced in '95 brought most of the revenues down to the bottom line. That's because we were able to provision new lines and services from idle capacity in an existing plant." Significantly, Mr. Smith pointed out that "With a switched digital broadband architecture, we'll be able to provision second and third lines at about a fifth the cost of a traditional primary line."
Mr. Smith added that "hand-in-hand with the growth in secondary lines has been strong growth in demand for value added services" such as Call Waiting, Voice Messaging and Caller ID. Mr. Smith concluded on this point that: "With only these two drivers -- additional lines and value-added services -- we expect growth in secondary residential lines and value-added services to drive revenues per Bell Atlantic household from $27 today to above $50 by the end of the decade." But, he added, while these opportunities are "exciting" in themselves, "the profit potential per household really opens up when we add the new opportunities -- long distance, data connectivity and video -- to the package."
At the same time that revenues are expected to go through the roof, here's what Ray Smith said in March 1996 about the expense side of the ledger: "In 1995 we assumed industry leadership in cash expense per access line. This year, we intend to reduce employees per 10,000 access lines to 26.5. Bottom line -- we will take another $300 million in expense out of our network business this year alone."
Chairman Smith's rosy predictions are already coming true. Just last week the Wall Street Journal of April 19, 1996, reported strong earnings growth for the first quarter of 1996 for Bell Atlantic and two other regional Bell companies. According to the Wall Street Journal, Bell Atlantic's first quarter income rose by 14% over the first quarter of 1995. These "healthy gains" for the Bell companies were said to have resulted from "surging demand for second telephone lines, recovering regional economies, favorable state regulatory climates -- and virtually no competition for their core telephone services." According to one Wall Street analyst quoted in that story, these factors have combined to give the regional Bell companies a virtual "license to print money."
All this, of course, was before Bell Atlantic announced its proposed merger with NYNEX to form a $50 billion telecommunications giant, which will still be called Bell Atlantic, but which will now be headquartered in New York City. In announcing that merger, Bell Atlantic said that it expected to save approximately $300 million per year from a reduction of 3,000 corporate and administrative management positions, $300 million per year from operations systems, and another $250-$300 million of incremental purchasing efficiencies -- or a total of $850-$900 million of annual cash savings for the merged company as a whole. As the Company stated in its merger announcement on April 22, 1996: "These savings, coupled with new revenue and margin opportunities in long distance, video and other network services, are expected to create substantial shareholder value for the new Bell Atlantic."
Why do I mention these profit potentials? Well, first of all, during the Bell Chapter 30 case, my Office argued that the price cap formula proposed by the Company was much too generous and would quickly result in the Company earning massive excess profits, particularly when profits from Yellow Pages were included. We therefore proposed that any profits above a just and reasonable level as determined by the Commission, should be shared 50/50 between shareholders and ratepayers. That is, shareholders would be able to retain 50% of profit over and above a reasonable return, while ratepayers would benefit from the other half of the profits through reduced rates. In this way, both the Company's shareholders and ratepayers would benefit from expected savings from technological and market advances. The Commission rejected our proposal for profit sharing, however, stating at page 88 of its June 1994 Order that such protection for ratepayers was unnecessary. Rather, the Commission stated: "The rate freeze which we are imposing on the Company's rates for protected services until December 31, 1999, is a sufficient safeguard in this respect."
Whether or not we actually ever had a rate freeze, of course, is now the subject of dispute before the Commission in a pending proceeding. But I've attached to my testimony the Press Release that Bell Atlantic issued on July 15, 1994, when it accepted the alternative regulation plan authorized by the Commission. On page 2 of that Press Release, Bell Atlantic stated:
In addition to accelerating Bell Atlantic's deployment of its broadband telecommunications network, the plan caps basic telephone service rates for all residence and business customers through 1999.
I would urge the members of this Committee to read that sentence again, and ask yourselves what Bell Atlantic could have possibly meant when it said that the plan "caps basic telephone service rates for all residence and business customers through 1999."
Despite this statement, Bell has now proposed to increase its basic dial tone charge for all residential customers by an average of about $2.90 per month or nearly $35 per year. This increase would be partially offset for customers who use touch tone service by the elimination of the 93 cent per month touch tone charge. In addition, customers who receive unlimited flat rate usage service in densely populated urban areas will see reductions in flat rate service which will result in overall rate reductions for those customers. Customers in urban areas who take limited usage service, including low income lifeline customers, and all rural customers would see overall basic service increases averaging about $2 per month.
While even this $2 per month increase is clearly inconsistent with a basic service rate freeze, my greater concern is where the Company plans to go from here. If the freeze is lifted, will this case represent just the first in a series of cases in which rates for basic residential service will be increased in some areas of Pennsylvania in order to let Bell reduce rates for more competitive services and customers? I have said before, and I will say here again, that Bell should come forward and tell this General Assembly and tell the Public Utility Commission and tell the people of Pennsylvania, how high it intends to raise basic telephone rates. It is particularly important for Bell to say how high rates could go for those rural Pennsylvanians who are the least likely to see competition for telephone service anytime soon.
Bell has said that it is necessary to bring its rates closer to the costs of providing service. Bell insists, however, that its specific cost information is proprietary and therefore it cannot be revealed at this hearing. Our Office is trying to get this information opened to the public. I would note, however, that in the universal service case now pending at the Commission, other telephone companies have presented non-proprietary data which suggest that the cost of serving some of Pennsylvania's most remote rural telephone exchanges is more than $100 per month. Currently Bell charges about $8.60 per month for basic service with a minimal level of usage. Bell has proposed in the current rate rebalancing case to raise that level to $10.75. Bell and a number of other telephone companies have suggested in the current universal service investigation that a $25 per month charge would be a reasonable level that would not cause customers to drop off the system. It should be noted though that this $25 per month would only cover the charge for a dial tone and touch tone, with a minimal usage package of about three outgoing calls per month. I want to be clear that Bell has not proposed that it will raise its rates to $25 per month, let alone the higher number which reflects what Bell claims to be its true cost of providing basic service in its highest cost areas. But Bell has declined to say how high it does intend to raise basic rates and what limit, if any, it would accept on basic service rate increases in the future.
I would also note that it should not simply be assumed that residential service is being subsidized in all or even much of Pennsylvania. I would encourage anyone interested in this subject to read the decision issued April 11, 1996, by the Washington State Utilities and Transportation Commission which found that residential service provided by the Bell company, U.S. West, in that geographically diverse state was not being subsidized. The Washington State Commission found that "the evidence is overwhelming that local exchange service does cover its total service long run incremental costs -- even as measured by the Company." Order at 79. The Washington Commission rejected U.S West's proposal to raise urban residential rates to $21.85 per month and rural rates to $26.35. Instead, the Washington Commission set a flat rate of $10.50 per month for all U.S. West customers throughout Washington State.
It is my hope that we can convince a majority of the current Public Utility Commission that no Bell customer's basic service rates in Pennsylvania should be allowed to increase by one penny between now and December 31, 1999. In other words, I would simply like to see the promise contained in the Bell statement of July 15, 1994 become a reality. That is, as Bell stated at that time: basic service rates would be capped "for all residence and business customers through 1999."
To this Committee, however, I would suggest that if Chapter 30 allows telephone companies to raise basic protected service rates over and above the level allowed in the overall price index, at the same time that the company's revenues are soaring and its expenses are plunging, then perhaps there is a gap in Chapter 30. As you recall, Chapter 30 established a special category of services, including basic residential service, called "protected services." In order to be approved under Section 3004(d) of Chapter 30, an alternative rate plan must ensure "the continued affordability of protected telephone service." Yet, here we see that the most basic protected residential services for many Bell customers are being subject to rate increases that are many times greater than the average increase which is permitted for all non-competitive services under the Bell price formula. I would support an amendment to Chapter 30, which already has been introduced in the House of Representatives, at HB 2544, which would limit the increase under an alternative form of ratemaking for protected services to no more than the average increase allowed under the overall price formula. In other words, if the price formula established by the Commission allows a telephone company to raise rates by 2% in one year, then the rates for each protected service could be raised by no more than 2% in that year. Quite simply, I think the General Assembly should take this step to protect protected services. Otherwise, what was the point of creating this category of services, if we are simply going to allow the subscribers to those services -- typically those with the fewest competitive alternatives -- to bear the full brunt of the telephone company's "rate rebalancing" efforts.
I would note in this regard that the Colorado Legislature included a provision in its 1995 telecommunications reform law which specifically prohibits increases in residential basic local exchange service in any year which exceed the level of inflation minus a telecommunications productivity factor. Such a provision in Pennsylvania would prevent Bell from increasing basic residential rates in the future by more than the inflation minus 2.93% formula approved by the Commission for Bell's overall rate levels. Such a provision could also prevent substantial basic rate increases through rate rebalancing that would be possible under the terms of other companies' alternative rate plans that have been filed at the PUC.
I would also urge the General Assembly to eliminate the provision in Section 3004(b), which allows a telephone company to reject an alternative regulation plan which is adopted by the Commission, and allows the company to opt to retain its existing form of regulation. This is what I call the "heads-I-win, tails-I-tie " provision. The problem with this provision is that the company, and only the company, gets a chance to "rule" on the Commission's order and to decide whether that order meets the company's corporate goals. Ratepayers have no similar choice. As long as this provision remains in the Act, I think it will be exceedingly difficult for the Commission to balance the interests of the utility and its ratepayers in determining an appropriate alternative rate plan. I would note that a similar provision in the Utah telecommunications law was struck down by the Utah Supreme Court in 1994 as an unconstitutional delegation of authority to the regulated company. As in the rest of the Public Utility Code, I believe that it is the Commission, not a single party, which should have the final say (subject to appeal) of whether a particular rate or rate methodology is just and reasonable.
Returning briefly to another portion of the Commission's 1994 deal with Bell, the network deployment, I anxiously await Bell's first biennial progress report in June 1996. I would note, however, that Commissioner Hanger already has pointed out that Bell Atlantic's investment in the Pennsylvania network was actually lower in 1993 and 1994 than it was in 1990, 1991, and 1992. Perhaps more significantly, I would also note that Bell Atlantic Chairman Ray Smith has made it clear that Bell Atlantic has been able to finance its broadband network without having to raise additional outside capital. As stated by Mr. Smith in his March 19, 1996, presentation:
Switched broadband offers superior capital returns, higher margins, and better productivity than the hybrid fiber-coax alternative. What's more, its deployment is part of our ongoing network modernization. We can build this network within current book depreciation levels.
Yes, but what about the impending threat of competition. I am certain that you have heard that Bell Atlantic is about to be subject to significant competition which will cut into its profit margins and require it to raise rates in high cost areas. But when Ray Smith spoke last month to Wall Street, he had a different perspective. Talking about growth in the telecommunications consumer market, he said:
Conventional wisdom has said that competition and price discounting will erode the local phone company's margins in this market.
This is misguided thinking. Given the ability to package and provide a far more diverse product mix without higher levels of capital investment, we have an historic oppportunity to make the consumer marketplace a growth engine rather than a stagnant, subsidy-laden slow -growth business.
In summary, I tend to agree with Mr. Smith that Bell Atlantic's current financial prospects under today's regulatory framework are nothing short of spectacular. Which brings me to my fundamental question; that is, why do we need to raise basic dial tone rates in Coudersport? Isn't it enough that Bell has been totally released from profit regulation at the precise moment in its history when its potential profits are at their highest? Is it too much to ask that in exchange for this unlimited profit potential, Bell simply refrain from raising rates for basic services throughout Pennsylvania?
I hope that technological and competitive market developments will soon lead to lower prices and even better telecommunications service for all Pennsylvanians. In the meantime, I think that regulation must continue to protect basic service customers, particularly in areas where the benefits of technological and competitive advances are least likely to occur in the immediate future. To that end, I will continue to urge the Public Utility Commission to enforce its 1994 Bell rate freeze order and to take appropriate actions to protect the ratepayers of other telephone companies as well. I would also urge the General Assembly to take the steps outlined in my testimony in order to fulfill the original intent of Chapter 30 to ensure the availability of universal telephone service to all Pennsylvanians at just, reasonable, and affordable rates.