Price Caps Still Dominate Retail Phone Rate Regulation; Deregulation Gains Ground

Rate of return regulation applies to dominant incumbents in Alaska, Ariz., Hawaii, Mont., N.H., and Wash. The regimes allow varying pricing flexibility for services and markets subject to competition, but revenue from flexibly priced competitive services continues to count in rate-of-return calculations. Large incumbents have been rate deregulated in Ida., Neb., S.D. and Wyo., while N.Y. and W.Va. employ unique state-specific price regulation systems. Regulators or lawmakers in 10 states -- Ariz., Cal., Me., Md., Mich., Minn., N.M., Okla., Vt. and W.Va. -- are considering extending or replacing price- based regulatory regimes for their largest incumbents. Decisions are expected this fall and winter (see details in White Paper, this issue).

For midsized incumbents, states are about evenly split between price caps (20 states) and rate of return (22). Hawaii, Del., Md.., R.I. and D.C. have no midsized incumbents. Mich. and W.Va. have unique systems. S.D. and Wyo. totally deregulated rates for midsized carriers.

Small incumbents -- generally under 50,000 lines -- remain under rate of return regulation in 30 states. But most of those states let small incumbents petition for alternative price-based regulation or for pricing flexibility within the RoR system. Small incumbents are under price caps in 6 states and under unique systems in 2 states, while 9 states fully deregulated small incumbents’ retail rates. Hawaii, Del., R.I. and D.C. have no small incumbents.

In 27 states, CLEC rates are presumed competitive. Changes get regulatory staff review, but usually aren’t contested. D.C. and 17 states don’t regulate CLEC rates. But 6 states have limits on CLEC rate changes. In N.J. and Ohio, CLECs’ initial rates for basic exchange and vertical services become de-facto rate caps: Any rise must be justified. In Neb., CLEC basic-service increases exceeding 30% must be justified. Del. requires CLEC rates stay above a cost floor. Ill. requires CLECs that accept universal service subsidies stay below benchmark rates.

Ariz. is unique. The utility regulation code, embodied in the state constitution, requires earnings- based regulation of public utilities. CLECs are no exception. But a 2001 state Supreme Court ruling spared regulators from having to hold endless CLEC rate cases. The ruling gave regulators broad discretion to interpret the relationship between CLECs’ rate bases and their rates, so regulators can examine individual rate changes’ earnings implications without having to conduct a general earnings review.

But states are edging toward rate deregulation, at least for their largest incumbents. Neb., S.D. and Wyo. have ended retail telecom rate regulation. Six states have enacted major telecom deregulation laws this year. In Tex., SB-5 will phase out retail rate regulation statewide by 2007 except in rural communities where the PUC determines there’s no meaningful competition. The law also vests video franchising with the PUC, not municipalities. But the law has been challenged in the state courts and its application may be stayed.

Utah’s SB-108 deregulated retail rates for all Qwest services other than residential basic exchange -- and allowed even that to be deregulated in markets where local competitors offer service. An Ala. law (SB-114) lets incumbents elect a price regulation program that will phase out most retail rate regulation by 2008. By then, services other than basic local and vertical services will be deregulated, and basic local rates indexed to the Consumer Price Index.

Ida. enacted HB-224, which gave Qwest local service pricing flexibility by replacing rate-of-return on basic exchange with temporary price caps that will expire in 2008. All other retail services in Ida. had been deregulated under previous laws. In Ia., HF-277 affirmed a presumption of statewide effective competition for all services except single-line basic exchange, meaning rates are deregulated. The law requires basic exchange rate deregulation at an incumbent’s request unless regulators can prove competition fails to constrain pricing. Mo. enacted SB-237, which ended rate regulation of retail service bundles. It requires rate deregulation of retail stand-alone services in any market the incumbent faces multiple unaffiliated competitors.

Other states have taken major strides down the path of deregulation. Rate regulation is confined to basic local service in Ark., Ida., Ind., Ia., Minn., N.D., Tex. and Utah. Other states provide for removal of all retail rate regulation in competitive markets. These include Ark., Ia., Kan., Mich., Mo., Utah and Wis. N.J. and N.C. have deregulated rates for multiline business service. Me. and Colo. allow market-specific rate deregulation of multiline business services. Ind., Mo., S.C. and Tenn. have deregulated rates for bundles of telecom services, even when bundles include services rate regulated individually.

Spinoffs of dominant incumbent telcos in Hawaii and Nev. to new owners aren’t expected to change their retail rate regulation. In May, Verizon closed the sale of its Hawaiian wireline operation to N.Y.-based Carlyle Group, which reorganized the company as Hawaiian Telecom. The PUC included a sale-approval condition barring the new owners from filing a general rate case before 2009. The firm also remains under a state law requiring cost-based rates and earnings-based controls until the PUC finds effective local competition exists. Hawaiian Telcom is the state’s only incumbent telco.

In Nev., Sprint notified the PUC in Aug. it would spin off its local exchange operation, the state’s largest incumbent, to LTD Holdings as part of a nationwide local exchange spinoff triggered by its merger with Nextel. Sprint said there are no plans to change the telco’s Nev. price cap regulation program, which runs over 2 more years.

In recent regulatory action, the Vt. Public Service Board last week approved a new 3-year price cap regime for Verizon that will continue rate regulation of most existing services. It also would give Verizon the option to avoid certain rate reductions by extending broadband to unserved communities. The board (Case 6959) rejected a Verizon proposal that would have deregulated rates for most retail services, allowed remaining rate-regulated services to rise up to 10% per year, and reduced state service quality oversight. The board said competition has been on the increase in Vt., but Verizon still enjoys a dominant position in the local exchange market: “More significantly, we find no basis on which to conclude that these competitors can and will deter Verizon from increasing its prices.”

The adopted plan caps rates for existing services at present levels until 2008. But the board said it decided to give Verizon flexibility to meet competition by deregulating rates for new services introduced while the new plan is in effect, except that new services can’t be priced below cost floors. The plan also requires Verizon to reduce business local service and toll rates by $8.2 million, with another $7 million in cuts held in abeyance pending Verizon’s separation of Yellow Pages operations from white pages listings.

The Mo. PSC granted partial approval to an SBC proposal to deregulate retail rates in dozens of its local exchanges where competitors operate. The PSC approved rate deregulation in 26 of 29 residential markets SBC requested, and in 45 of 61 business markets SBC wanted. The PSC (Case IO-2006-0092) granted the petition under a 30-day process spelled out in a 2005 law that requires rate deregulation in any market where there’s at least one facilities-based wireline CLEC and one wireless competitor providing local service. The PSC said the rejected exchanges were turned down either because they didn’t meet the competition criteria or were added late to SBC’s petition, allowing insufficient time for study.