ARCHIVED -  Telecom Decision CRTC 88-4

Telecom Decision

Ottawa, 17 March 1988

Telecom Decision CRTC 88-4

BELL CANADA - 1988 REVENUE REQUIREMENT, RATE REBALANCING AND REVENUE SETTLEMENT ISSUES

BRITISH COLUMBIA TELEPHONE COMPANY - TO TRANSCANADA RATE SCHEDULE REVENUE SETTLEMENT ISSUES

Table of Contents

I INTRODUCTION

II ACCESS TO AND QUALITY OF SERVICE

A. Access to Service Issues

B. Quality of Service Results

1) Quality of Service Indicators
2) Excluded Trouble Reports
3) Telesat Canada Earth Stations - Remote Northern Ontario

III CONSTRUCTION PROGRAM

IV REVENUES AND EXPENSES

A. Elasticity

1) Introduction
2) Positions of Interveners
3) Bell's Reply
4) Conclusions
5) Model Methodology Review

B. Operating Revenues

1) Introduction
2) Current Status of the JMP
3) Impact of 10% Federal Sales Tax
4) Non-Penetration Lines
5) Miscellaneous Revenues
6) Conclusions

C. Operating Expenses

1) 1987 and 1988 Forecasts
2) Vehicle Maintenance Expense
3) Marketing and Development Expense
4) Uncollectible Revenues
5) Access to Billing Envelopes by Outside Advertisers
6) Conclusions

V INTERCORPORATE TRANSACTIONS

A. Compensation for Temporarily Transferred Employees

1) Background
2) Positions of Parties
3) Conclusions

B. Procedures for Purchases from Affiliates Excluding Northern Telecom Canada Limited (NTCL)

1) Background
2) Positions of Parties
3) Conclusions

C. Transfer of Assets

VI DEFERRED TAX LIABILITY

A. Background
B. Positions of Parties
C. Conclusions

VII FINANCIAL CONSIDERATIONS

A. General

B. Rate of Return

1) Summary of Evidence
2) Comparable Earnings
3) Flotation Costs
4) Other Concerns

C. Conclusions

VIII REVENUE REQUIREMENT

A. 1987 Revenue Requirement
B. 1988 Revenue Requirement
C. Distribution of 1988 Excess Revenues

IX RATE REBALANCING

A. Background
B. Costing
C. Access Cost Recovery
D. Universal Service
E. General Economic Impact of Rate Rebalancing
F. Impact on Various Classes of Subscribers
G. Competition and Bypass
H. Future Rebalancing Applications

X REVENUE SETTLEMENT ISSUES

A. Removal of Single Member Traffic from the Telecom Canada Revenue Settlement Plan

1) Background
2) Positions of Parties
3) Conclusions

B. Impact on Independent Telephone Companies

1) Background
2) Positions of Parties
3) Conclusions

XI TARIFF REVISIONS

A. Bell Canada Tariff Notices 2270A, 2409 and 2414

1) Primary Exchange Services
2) Local Channel Service
    a) Bell's Application
    b) Positions of Parties
    c) Conclusions
3) Centrex Rates
4) Other Exchange Services
5) Service Charges
6) MTS/WATS/800 Service
    a) Bell's Application
        (1) TransCanada Message
        (2) Canada WATS - Non Intra Zones
        (3) Canada 800 Service Zones
        (4) Canada-U.S. 800 Service
        (5) Intra-Bell Message
        (6) Canada WATS - Intra Zones
        (7) Canada 800 Service - Intra Zones
        (8) WATS/800 Service Customer Impact
    b) Positions of Parties
    c) Conclusions

B. Other Rates Issues

1) Interexchange Voice Grade Channel (IXVG) Rates
2) Failure by Bell to Conform to its Tariffs

C. B.C. Tel Tariff Notices 1555 and 1555A

D. Tariff Filings

XII FOLLOW-UP ITEMS

A. Status of Items Identified in Decision 86-17
B. Summary of Items Identified in this Decision
C. Follow-up Procedure

I INTRODUCTION

On 3 February 1987, the Commission received two applications from Bell Canada (Bell) under Tariff Notices 2269 and 2270. In the letter that accompanied these applications, Bell pointed out that in Interexchange Competition and Related Issues,Telecom Decision CRTC 85-19, 29 August 1985 (Decision 85-19), the Commission had indicated its intent to initiate a public review of the issues related to rate rebalancing. In this context, the applications constituted a specific rate proposal for the Commission's consideration.

In general, Tariff Notice 2269 proposed rate reductions for TransCanada Message Toll Service (MTS) and for non-intra company Wide Area Telephone Service (WATS), and rate increases for non-intra Canada 800 Service. It also proposed monthly rate increases for such local services as Centrex access lines and business and residence individual, two-party, four-party and trunk lines. These proposed tariff revisions were to take effect on 1 July 1987.

Tariff Notice 2270 proposed further tariff revisions, which were to take effect 1 January 1988. In general, this Tariff Notice proposed rate reductions for intra-company MTS, WATS and 800 Service, and Canada-U.S.800 Service. It also proposed monthly rate increases for certain local services, including further increases to rates which would already have been raised by virtue of Tariff Notice 2269.

On 4 March 1987, the Commission wrote to Bell in reference to the rate revisions proposed in Tariff Notice 2269. The Commission stated that it was not prepared to consider the proposed local rate increases without a full public process, including an oral public hearing. If participants were to be permitted adequate preparation time, such a hearing could not take place before the fall of 1987. As a result, the local increases proposed to take effect 1 July 1987 could not be implemented. The Commission was prepared to consider, by way of a written proceeding, the proposed revisions to TransCanada MTS, non-intra WATS and non-intra 800 Service rates. Bell was asked to advise the Commission whether or not it wished to proceed with these rate revisions by way of a paper proceeding.

By letter dated 11 March 1987, Bell withdrew Tariff Notice 2269 in its entirety. The company stated that it was not prepared, at that time, to implement rate reductions to TransCanada MTS and non-intra WATS and 800 Services rates without corresponding increases to local rates. Bell advised the Commission that it intended to file an amendment to Tariff Notice 2270 that would integrate the tariff revisions proposed in Tariff Notices 2269 and 2270, and would propose that these integrated rates take effect on 1 January 1988.

On 17 March 1987, Bell filed the amendment as Tariff Notice 2270A. It also provided an updated version of the "Memorandum on Rate Rebalancing" that it had submitted in support of Tariff Notices 2269 and 2270. Bell estimated that the proposed tariff revisions would have a net negative financial impact of $2.0 million in 1988.

On 20 March 1987, the Commission issued CRTC Telecom Public Notice 1987-15 (Public Notice 1987-15) which announced a public hearing to consider the tariff revisions filed under Tariff Notice 2270A and which set out the procedural directions applicable to the proceeding. The hearing was scheduled to begin on 27 October 1987 in Hull, Québec. The public notice noted that the Commission had joined British Columbia Telephone Company (B.C. Tel) to the proceeding in order to consider any TransCanada toll rate revisions that B.C. Tel might wish to file. By letter dated 3 March 1987, B.C. Tel had advised the Commission that it would be filing such revisions. The company had also informed the Commission that it had no immediate plans to revise local or other toll rates.

Public Notice 1987-15 also announced the Commission's intention to consider, in the same proceeding, the question of whether or not the Telecom Canada settlement revenues should exclude revenue from Canada-U.S. and Canada-Overseas traffic that is carried by the facilities of only one Telecom Canada member. This issue had been raised previously in Bell Canada, British Columbia Telephone Company and Telesat Canada: Increases and Decreases in Rates for Services and Facilities Furnished on a Canada-Wide Basis by Members of the TransCanada Telephone System, and Related Matters, Telecom Decision CRTC 81-13, 7 July 1981 (Decision 81-13), and Bell Canada - Review of Revenue Requirements for the Years 1985, 1986 and 1987, Telecom Decision CRTC 86-17, 14 October 1986 (Decision 86-17).

On 21 April 1987, both Bell and B.C. Tel filed responses to the Commission's first series of interrogatories in the proceeding. In its response to interrogatory Bell(CRTC)20Mar87-401, Bell provided revenue and expense forecasts for the year 1988. These forecasts indicated that the company could anticipate a 1988 rate of return on average common equity of 13.2% on a regulated basis. This rate of return was near the top of the allowed rate of return range (12.25% to 13.25%) for 1987 which had been established by the Commission in Decision 86-17. Bell's financial forecasts for 1988 were based on the company's January 1987 View, which, in turn, relied on data from mid-1986. The assumptions underlying the January 1987 View and the 1988 forecasts, including those assumptions concerning overall economic activity within Bell's operating territory, were called into question by more current information. In addition, Bell's first quarter 1987 financial results were considerably better than forecast in the January 1987 View.

In light of these circumstances, the Commission issued CRTC Telecom Public Notice 1987-28, dated 1 June 1987 (Public Notice 1987-28), which initiated a proceeding to establish Bell's 1988 revenue requirement, including its rate of return on average common equity. The public notice announced that this proceeding would include a consideration of any resulting revisions to Bell's 1988 rate schedules, including, but not limited to, the revisions proposed in Tariff Notice 2270A. It also announced that these issues would be considered in the context of the proceeding initiated by Public Notice 1987-15.

The unexpected strength of Bell's financial results for the first quarter of 1987 raised the further issue of whether Bell's rate of return for 1987 would fall within the range established in Decision 86-17. By letter dated 15 May 1987, the Commission asked Bell to file additional information concerning the company's 1987 financial performance. This information, which included an update (the June update) to Bell's January 1987 View of 1987, was filed with the Commission in confidence on 1 June 1987. On the same date, the company filed Tariff Notice 2398, which was an application for interim approval of some of the components of Tariff Notice 2270A. Tariff Notice 2398 requested revisions to Bell's TransCanada rate schedule, to take effect 1 July 1987, and to Bell's non-intra WATS and 800 Services, to take effect 1 October 1987.

On 5 June 1987, the Commission wrote to Bell in reference to Tariff Notice2398 and the 1987 financial information that the company had provided. In its letter, the Commission stated that it accepted the revised forecast of the company's operating expenses contained in the June update. This forecast indicatedan increase over 1986 actual expensesthat was significantly lower than theanticipated increase in combined inflation and demand factors.

The Commission further stated that it considered that the June update forecast of total operating revenues was too low. The Commission based this assessment on a) the company's April 1987 actual-to-date operating revenues (which reflected the strong performance of the economy in Bell's operating territory), and b) the historical tendency for average operating revenues to be higher during latter part of the year.

Based on this analysis, the Commission informed Bell that it had come to the preliminary view that, absent rate revisions resulting in net revenue reductions of $35 to $40 million, Bell would earn more than the top end of its allowed rate of return range with respect to the second half of 1987 on an annualized basis. The Commission stated that, in order to bring about the necessary revenue reductions, it was considering granting interim approval, effective 1 July 1987, to certain of the rate revisions proposed in Tariff Notices 2398 and 2270A. In general, the rate revisions under consideration involved decreases to Bell's TransCanada and intra-company MTS rates. The Commission also stated that final approval of any of the proposed rate increases would require a public process. The Commission invited Bell to file submissions concerning the interim approvals contemplated by the letter and asked the company to file the tariff pages necessary to implement the rate revisions in question.

On 16 June 1987, Bell filed the requested tariff pages under Tariff Notice 2409. By letter of the same date, Bell submitted its comments on the rate revisions contained therein. For various reasons, the company asked that only those changes associated with the TransCanada MTS be approved.

The Commission replied to Bell's submissions by letter dated 23 June 1987. With the exception of the changes to Bell's intra-company MTS rates, the Commission granted interim approval, effective 1 July 1987, to the rate revisions specified in Tariff Notice 2409. Bell had estimated that the rate revisions contained in Tariff Notice 2409 would result in a net revenue reduction of about $32 million in 1987. In order to bring the company's net revenue reduction to an amount between $35 and $40 million, the Commission ordered further decreases to Bell's intra-company MTS rates. The company filed these further rate reductions under Tariff Notice 2414, which was subsequently approved by the Commission effective 1 July 1987.

Also on 23 June 1987, the Commission issued CRTC Telecom Public Notice 1987-33 (Public Notice 1987-33), which modified the procedures established in Public Notices 1987-15 and 1987-28. In response to a request on 9 June 1987 from Bell, the Commission postponed certain filing dates that related to the Memoranda of Support the company was required to prepare in connection with the revenue requirement portion of the proceeding. Most other dates remained unaltered.

On 7 August 1987, the Commission issued CRTC Telecom Public Notice 1987-44 announcing a regional hearing to take place on 28 and 29 September 1987 in Vancouver, British Columbia. This hearing was intended to provide interested persons with an opportunity to present their views on issues relevant to B.C. Tel's participation in the proceeding. The public notice referred to the interim approval given to Tariff Notice 1555A, which B.C. Tel had filed with the Commission on 16 June 1987 proposing reductions to the company's TransCanada rates. These interim rate reductions had come into effect on 1 July 1987.

On 14 October 1987, in Hull, Québec, the Commission conducted a pre-hearing conference in connection with the proceeding. At that time, the Commission dealt with outstanding preliminary matters, including requests for further responses to interrogatories and for public disclosure. The decision arising out of the pre-hearing conference was issued on 20 October 1987.

The Commission received a total of 36 interventions and 381 comments in this proceeding. The central hearing was held from 27 October to 11 December 1987 before Commissioners Louis Sherman (Chairman), André Bureau and Rosalie Gower.

The following appeared, were represented or filed final argument: Bell; B.C. Old Age Pensioners' Organization, Council of Senior Citizens' Organizations of British Columbia, Federated Anti-Poverty Groups of B.C., Local 1-217 IWA Seniors, the Senior Citizens' Association, the West End Seniors' Network (collectively BCOAPO et al); B.C. Tel; Canadian Business Telecommunications Alliance, Association of Competitive Telecommunications Suppliers, Canadian Manufacturers' Association, Canadian Association of Message Exchanges, Inc., Canadian Association of Data and Professional Service Organizations, Canadian Alarm and Security Association, Canadian Bankers' Association, Canadian Radio Common Carriers Association, Ontario Hotel and Motel Association (collectively, CBTA et al); Canadian Independent Telephone Association (CITA); CNCP Telecommunications (CNCP); Consumers' Association of Canada (CAC); Director of Investigation and Research, Competition Act, Consumer and Corporate Affairs (the Director); 'edmonton telephones' 'et'; Fédération Nationale des Associations de Consommateurs du Québec (FNACQ); Fédération des ACEF du Québec (ACEF); Carlyle Gilmour; Ministry of Culture and Communications, Government of Ontario (Ontario); Ministry of Communications, Government of Québec (Québec); Ontario Telephone Association (OTA); National Anti-Poverty Organization (NAPO); Communications Programs Branch, Ministry of Provincial Secretary and Government Services, Province of British Columbia (B.C.); Québec-Téléphone; Le Syndicat des travailleurs et travailleuses en communications et en électricité du Canada (STCC); and the Telecommunications Workers Union (TWU).

The Canadian Association of Message Exchanges, Inc., and the Canadian Association of Data and Professional Service Organizations submitted no argument with respect to rate rebalancing issues. In part IX of this decision, references to argument submitted by CBTA et al should be read accordingly.

II ACCESS TO AND QUALITY OF SERVICE

A. Access to Service Issues

In Review of the General Regulations of the Federally Regulated Terrestrial Telecommunications Common Carriers, Telecom Decision CRTC 86-7, 26 March 1986 (Decision 86-7), the Commission directed the telephone companies under its jurisdiction to provide their single-line customers with a detailed itemization of service and equipment charges at service commencement, after any service or equipment changes, after general rate proceedings and, at a minimum, once a year. Bell's current billing practice complies with these requirements, while B.C. Tel's exceeds them. In its regular monthly billings, B.C. Tel itemizes charges for, among other things, specific custom calling features, Touch-Tone calling and various models of rented telephone sets.

In its final argument, CAC requested the Commission to direct Bell to file a study of the costs which would be associated with providing in its monthly billing statements to subscribers the same level of itemization of the charges incurred for services and equipment rentals as is currently provided by B.C. Tel, and to allow interested parties to comment on an appropriate level of itemization.

CAC stated that, in light of the large number of services and types of equipment that can be provided, adequate consumer protection requires the monthly disclosure of a subscriber's service and equipment rental charges. It stated that such disclosure could assist subscribers in coping with local rate increases by enabling them to identify charges, such as the $2.55 monthly charge for Touch-Tone Service, which they may choose to eliminate. It also argued that Bell would not incur additional costs for new printers to provide monthly billing details in that existing printers now itemize accounts at least once a year.

In reply, Bell stated that it would cost an additional $100,000 per month to itemize charges on its 6 million customer billings. It added that monthly itemization would probably also require the acquisition of one or two additional printers at a cost of about $l million each. It also noted that there have not been customer complaints or requests for changes to its current process. Finally, Bell noted that, in the Terms of Service proceeding which resulted in Decision 86-7, CAC had advocated the adoption of the billing process now practiced. It therefore opposed the CAC request.

The Commission considers that Bell has provided a satisfactory response to the matters raised by CAC regarding monthly billing information and, accordingly, denies CAC's request.

B. Quality of Service Results

1) Quality of Service Indicators

On 9 November 1982, the Commission issued Quality of Service Indicators for Use in Telephone Company Regulation, Telecom Decision CRTC 82-13, (Decision 82-13). This decision established a set of quality of service indicators and gave interim approval to standards for some indicators and final approval to standards for others. On 6 September 1985, the Commission issued Bell Canada - Standards for Quality of Service Indicators, Telecom Decision CRTC 85-20 (Decision 85-20), in which it finalized the standards for all indicators in Bell's territory other than remote areas in northern Ontario, northern Québec and eastern Northwest Territories (collectively, the Remote North). The standards for these latter indicators were approved by the Commission in March of 1987. The approved standards for the Remote North were based on an August 1985 Report filed by Bell, with some modifications required by the Commission in the areas of Long Distance Transmission Quality, Local Network Blocking and Community Level Reporting.

To monitor the service quality provided by Bell, the Commission requires the company, pursuant to Decision 82-13, to furnish, on a quarterly basis, monthly details of its performance. Bell is required to provide detailed explanations and corrective action plans when any indicator falls below standard at the reporting unit level for three consecutive months or for a total of seven of any consecutive twelve months. These explanations are provided until the reporting unit has met the standard for three consecutive months.

In this proceeding, the Commission has assessed the company's performance results for the year 1986 and the first three quarters of 1987 with respect to 41 separate indicators pertaining to provision of service, repair service, local service, long distance service, operator services, directory assistance and billing service. The Commission has also assessed the complaints received from Bell subscribers.

The results indicate that the company's performance has been, and continues to be, above standard with the exception of two service quality indicators (indicators 12(b) & 13(d)) relating to the provision of service and one service quality indicator (indicator 23(d)) relating to repair service.

Indicator 12(b) gives the percentage of service connection commitments for residence service not requiring a customer premises visit which were met by the company. This indicator exhibited below standard performance throughout the Ontario region during the second quarter of 1987. The Commission notes the corrective action plans put in place by the company in this regard and the significant improvements in this indicator's results for the third quarter 1987.

Indicator 13(d) gives the proportion of customers satisfied with the availability of facilities for regrades inside the base rate area. In Decision 86-17, the Commission directed the company to review its action plans to resolve long standing below standard performance exhibited by this indicator in the Ontario region during 1984, 1985 and the first quarter of 1986. Below standard performance continued throughout 1986 and the first quarter of 1987. The Commission notes, however, that indicator 13(d) has exhibited above standard performance during the second and third quarters of 1987.

Indicator 23(d) gives the percentage of non-urban initial trouble reports for which a further report is received within one month of the receipt of the initial report, after corrective action has been taken on it. The repeated report may not involve the same precise problem, but involves the same line, trunk, circuit or station. This indicator exhibited below standard performance in the Ontario region during the last two quarters of 1986 and in both the Ontario and Québec regions in the third quarter of 1987. Company corrective action plans include increased preventive maintenance and a stronger emphasis on quality of workmanship.

Pursuant to Decision 82-13, the company is required to provide, on a quarterly basis, monthly service quality results for the Remote North. For these areas, there presently are standards pertaining to 13 of 16 separate service quality indicators for monitoring and assessing various aspects of the company's service performance. Bell is required to provide detailed explanations and corrective action plans when any indicator falls below standard at the reporting unit level for two consecutive quarters or when the results of a particular community are below standard on any indicator for four consecutive quarters. The data submitted by the company indicate that, during the first three quarters of 1987, performance has been above standard for all indicators except for indicator 2 (Installation Commitments: Percent Met) which was below standard in the first quarter of 1987.

The Commission is of the view that quality of service indicators are an important measure of the company's performance. The Commission notes that Bell's quality of service indicators have improved significantly over the seven quarters beginning with the first quarter of 1986 and encourages the company to maintain the high level of service which has been attained. The company is also expected to pursue effective corrective action plans where indicators are below standard.

2) Excluded Trouble Reports

In the proceeding leading to Decision 86-17, Mr. André Aubin, then Bell Vice-President (Operations Performance), under cross-examination by CAC, discussed at some length the reasons for excluding certain trouble reports from quality of service results. The reasons provided were:

(1) to avoid counting a trouble report more than once;

(2) to exclude reports generated for reasons other than repair or maintenance;

(3) to exclude reports generated by company personnel or surveillance systems (as opposed to reports generated by customers); and

(4) to exclude reports related to customer provided terminal equipment.

In its final argument in this proceeding, CAC noted a large increase in excluded trouble reports, expressed as a percentage of initial reports, between the first quarter of 1986 and the second quarter of 1987: from 14.8% to 21.3% for business customers, and from 18.5% to 23.9% for residence customers. CAC contended that Bell has an incentive to exclude trouble reports from its quality of service results. CAC requested the Commission to direct Bell to provide information on excluded trouble reports as part of its quarterly quality of service reports and to have an independent audit of excluded trouble reports conducted for the years 1985, 1986 and 1987.

In its reply argument, Bell referred to the statement of Mr. John M. Farrell, Vice-President (Corporate Performance), under cross-examination by CAC, that the increase in the percentage of excluded trouble reports stemmed from an increase in reports that are not of a repair or maintenance nature and the implementation of the Centralized Automatic Loop Reporting System (CALRS). The Commission notes that information provided by the company during the 1987 Construction Program Review (CPR) indicates that the percentage of Network Access Services (NAS) tested through CALRS has increased from 79% to 96% during the year 1986. The Commission is supportive of technological improvements such as CALRS that result in earlier detection of faults, since they tend to enhance the quality of service provided to subscribers.

The Commission notes, however, that the increase in CALRS NAS coverage (approximately 21%), while responsible for part of the increase in excluded trouble reports, does not seem to explain fully the large increases that have occurred. In the Commission's view, the existence of these increases is not of sufficient concern to warrant conducting an independent audit as requested by CAC. Nevertheless, it does persuade the Commission of the need for Bell to apply adequate internal control procedures to ensure that trouble reports are only excluded for proper reasons. As the record of this proceeding does not provide information in this area, the company is directed to file within 60 days, as a follow-up item to this decision, a report on the internal control procedures currently in place with respect to excluded trouble reports.

3) Telesat Canada Earth Stations - Remote Northern Ontario

In its final argument, CAC requested the Commission to direct Bell to enter into negotiations with Telesat Canada (Telesat) in order to recover costs associated with excessive outages of Telesat earth stations in remote northern Ontario. CAC argued that since the significant increase in average outage hours per trunk in remote northern Ontario results from outages of Telesat earth stations, Bell should take steps to recover the associated costs from Telesat.

During cross-examination, Bell stated that the outage increase was mainly caused by poor commercial power and older technology, in combination with the isolated location of the equipment which precludes quick maintenance response.

The Commission is satisfied that the outages in question are being caused primarily by the environment in which the equipment operates. Consequently, in the Commission's view, it would be inappropriate to direct Bell to attempt to recover the costs incurred as a result.

The Commission nevertheless considers that the increase in the average outage hours per trunk in remote northern Ontario during 1987 is significant, and encourages the company to attempt to alleviate this problem.

III CONSTRUCTION PROGRAM

In Bell Canada-1987 Construction Program Review, Telecom Decision CRTC 87-15, 22 October 1987, the Commission found Bell's January 1987 View of its construction program, as modified by the updates filed in that proceeding for the years 1987 and 1988, to be reasonable.

The company's July 1987 Management Plan, filed as part of the current proceeding, increases forecast 1988 expenditures by $92 million (4.4%). This forecast expenditure increase in the company's total capital program includes changes to usage category expenditures as follows:

The company explained that these changes are required to meet increases in the most recent forecast demand for the year 1988 for NAS net gain (9.4%) and long distance messages (3.0%).

These changes have resulted in a marginal increase in the company's cost/demand ratio for urban exchange facilities and a net reduction in the cost/demand ratio for intertoll facilities. In light of the associated demand increases, the Commission views the changes to the company's construction program for the year 1988 as reasonable.

IV REVENUES AND EXPENSES

A. Elasticity

1) Introduction

In its evidence in this proceeding, Bell relied on estimates of the price elasticity of demand for intra-Bell MTS that were based on econometric models filed in the proceeding leading to Decision 86-17. Based on these econometric models, and using data for the first quarter of 1974 to the second quarter of 1985, the company estimated the price elasticity for customer-dialed calls to be -0.44 and -0.49 for the modelled peak and off-peak periods, respectively.

In response to interrogatory Bell(CRTC)20Mar87-715, Bell provided TransCanada MTS price elasticity estimates based on econometric models of demand filed in the proceeding leading to Decision 85-19. The estimated long-run price elasticities for customer-dialed calling during the peak period were:

i) -0.24 (0-680 miles);
ii) -0.35 (681-1675 miles); and
iii) -0.54 (over 1675 miles)

For customer-dialed calling during the off-peak period, the estimated long-run price elasticities were:

i) -0.45 (0-680 miles);
ii) -0.76 (681-1675 miles); and
iii) -0.89 (over 1675 miles)

Bell indicated that its estimates of price elasticity of demand for WATS and 800 Service were not modelled, but based on judgment. The price elasticity of demand for WATS was assumed to be the same as the price elasticity of demand for customer - dialed MTS calls in the peak period. The price elasticity for 800 Service was assumed to be one-half of the elasticity for customer-dialed MTS calls in the peak period.

In response to Commission interrogatories, Bell also provided econometric model results using the company's specifications and a variety of alternative specifications given by the Commission, updated to include different time periods.

For intra-Bell MTS, the company models updated to the second quarter of 1987 provided price elasticity estimates of -0.43 for customer-dialed calling in the peak period and -0.53 for customer-dialed calling in the off-peak period. The alternative specifications provided price elasticity estimates ranging from -0.42 to -0.67 for customer-dialed calling in the peak period, and price elasticity estimates ranging from -0.50 to -0.76 for customer-dialed calling in the off-peak period. Some of these alternative specifications provided statistical results superior to those of the company models. For example, as provided in the response to interrogatory Bell(CRTC)8Sept87- 3719, the results obtained for certain specifications using the consumer price index (CPI) for Ontario and Québec as the measure of the price deflator in the intra-Bell peak model showed a smaller standard error, and better overall fit as indicated by the F-statistic, than the results produced by the company model, which used the implicit price deflator for Canadian gross domestic product as the measure of the price deflator.

In reference to TransCanada MTS, the models filed in the Decision 85-19 proceeding meet all the statistical criteria that the company uses to assess econometric models. However, these models, updated to the fourth quarter of 1986, exhibit various statistical problems, including autocorrelation, instability and multicollinearity. Furthermore, some of these updated models have statistically insignificant price elasticities. Subsequently filed models incorporating a serial correlation correction method (known as the Hildreth - Lu procedure) requested by the Commission solved the problem of first-order autocorrelation, but did not satisfy the company's stability test.

In final argument, Bell noted that the selection of variables to be included in the intra-Bell price elasticity models was a subject of considerable discussion in the proceeding. With respect to the use of alternative measures of economic activity for the intra-Bell peak model, Bell argued that the use of provincial rather than national variables would introduce data reliability concerns and in any event would not affect conclusions regarding the estimates obtained for price elasticity. With respect to its use of the implicit price deflator for Canadian gross domestic product instead of the consumer price index for Ontario and Québec as the measure of the price deflator in the intra-Bell peak model, Bell argued that its choice of the measure of the price deflator was appropriate, having regard to the fact that both business and residence sectors are represented in the peak model. Bell also noted that the CPI for Ontario and Québec measures price movements in consumer goods for Montréal and Toronto only. With respect to its use of the number of potential toll connections instead of the number of households as the measure of market size in the intra-Bell off-peak model, Bell argued that its choice of the measure of market size explicitly reflects the interdependence of toll calling amongst telephone network subscribers. Bell further argued that the models with the households variables were statistically inferior to the company model with the potential toll connections variable.

2) Positions of Interveners

Many interveners conducted extensive cross-examination of Bell's witnesses on price elasticity. The Director, Ontario, CNCP, CBTA et al and NAPO also addressed the topic of price elasticity of demand in final argument. In general, these interveners questioned the design and specifications of Bell's econometric models and expressed doubt about the accuracy of the company's price elasticity estimates.

In argument, the Director and CBTA et al criticized the extent to which data was aggregated in the econometric models that Bell used to derive its price elasticity estimates. Citing a hypothetical example of the difference in revenue calculations based on disaggregated versus aggregated elasticities, as provided in Director Exhibit 6, the Director submitted that the level of aggregation in Bell's models is very important to a determination of the company's expected revenues.

CBTA et al, noting that Bell's models were aggregated across mileage bands and over business and residence service, submitted that properly disaggregated models would provide higher elasticities and might be more robust.

The Director recommended that Bell be directed to improve its elasticity estimation methodology in the following ways:

i) by modelling business and residence NAS by province;

ii) by developing separate traffic data for residence and business subscribers through a deeper investigation of the source of data problems and by employing reasonable proxies;

iii) by using provincial data for income, economic activity and price deflators;

iv) by grouping mileage band data in a way which, by an objective statistical measure, minimizes information loss; and

v) by developing toll elasticity estimates based on the simultaneous disaggregation of data by service class, province, mileage band and peak/off-peak periods.

Ontario, noting that the updated model containing the TransCanada MTS price elasticity estimates failed the stability test, suggested that the company's revenue forecasts be adjusted to account for the use of an unstable model.

CBTA et al commented that the Bell marketing surveys, as described in Bell Exhibit 8, showed that by April 1987, many subscribers were unaware of the important elements of the rate reductions that had been implemented 1 January 1987. CBTA et al concluded that demand stimulation as a result of the 20% rate reductions would thus take more time to be fully recognized than was indicated by the lag structure in Bell's models.

CBTA et al noted from the response to interrogatory BCTel(CNCP)11May87-9 that the overall price elasticity estimate for intraprovincial toll service in British Columbia was about -0.6. In the view of CBTA et al, the Commission should use an elasticity figure for Bell that is not less elastic than -0.6.

NAPO submitted that the elasticities produced by Bell's models were inadequate. In particular, NAPO noted that constant elasticities were assumed in the Bell models, which were estimated using a double-log functional form, and argued that the price elasticity estimates produced by these models were not likely to be valid given the significant price reductions that came into effect on 1 January 1987. NAPO, therefore, suggested that Bell use non-linear models.

NAPO submitted that Bell's elasticity models were incapable of adequately predicting the company's operating revenues for 1988. NAPO further suggested that the Commission should closely monitor Bell's revenues and modelling processes in the coming years.

CNCP suggested that harmful multicollinearity was present in Bell's models. CNCP based its argument on CNCP Exhibit 3, which showed that, for intra-Bell MTS, changes in the estimated market size coefficients have been associated with changes of similar magnitude in the opposite direction in the estimated price coefficients.

The Director questioned the tracking record of Bell's elasticity models. He submitted that it was premature to judge the accuracy of any model on the basis of ten months of evidence.

3) Bell's Reply

In its reply argument, Bell submitted that the level of disaggregation recommended by the Director would entail the development of models for up to eighty segments for intra-Bell customer-dialed MTS alone. Bell argued that disaggregation schemes must always be tempered by the type of information required, by practical business considerations, as well as by the availability, reliability and variability of data.

Bell stated that the development of econometric models disaggregated by business and residence MTS was presently precluded by inaccuracies in the classification of data by business and residence class prior to 1983. However, the company indicated that it would pursue disaggregation by business and residence service class as more of the data required for the development of such models became available.

Based on its own analysis, Bell argued that the development of econometric models disaggregated by mileage band had not produced elasticity estimates that would lead it to different conclusions regarding the price responsiveness of demand for intra-Bell MTS. The company, however, indicated that it continuously monitors the issue of mileage band disaggregation and would use disaggregated elasticities if that use would improve the quality of information available for revenue estimation and rate setting purposes.

Bell disputed CBTA et al's claims that Bell's customers were not aware of important elements of the 1 January 1987 rate reductions. Bell argued that with the lapse of nine to eleven months and with the broad media coverage of the rate reductions, it would seem unreasonable to continue to assume relatively low consumer awareness of the January rate reductions.

With regard to the tracking performance of its elasticity models, Bell argued that the record of the proceeding showed that the impact of the 1 January 1987 intra-Bell rate reductions on revenues confirmed the impact estimated by its elasticity models. Bell submitted that tracking results based on six to ten months of evidence could provide substantial information regarding price elasticity.

Regarding the appropriateness of using the double-log functional form models to estimate the impact of significant price changes, Bell argued that the choice of functional form is primarily an empirical question. It stated that results based on the double-log form are corroborated by results based on many other functional forms, including forms that do not assume constant elasticity.

Regarding the presence of harmful multicollinearity in its models, Bell replied that the application of the Belsley, Kuh and Welsch multicollinearity test to its models did not suggest the presence of harmful multicollinearity.

4) Conclusions

The Commission notes the value of developing price elasticity estimates based on models that are disaggregated to a level at which they produce useful and desired information, provided the microrelations are all correctly specified and reliable microdata are used. However, given currently available data, the Commission has not been persuaded that, at this time, the level of disaggregation used in Bell's models is inappropriate. Neither is the Commission persuaded that harmful multicollinearity is present in Bell's models, or that different results would be obtained from the use of functional forms other than the double-log form.

The Commission is of the view that, in the course of the development of elasticity models, the selection of variables to be included in the models should be guided by both economic reasoning and statistical results. In this regard, the Commission notes that a number of alternative models examined in this proceeding produced comparable or, in some cases, better statistical results than Bell's. Further, the Commission was not persuaded that Bell's models were always more consistent with economic theory than the alternative models examined.

Taking all the evidence before it into consideration, the Commission has decided that, for the purposes of this decision, a price elasticity of -0.5 is to be used for intra-Bell customer-dialed MTS in the peak period, with elasticities for the first to fourth quarters, respectively, following a price change for the service of 30%, 60%, 80% and 100% of the long-run elasticity of -0.5. For the purposes of this decision, the Commission has also decided that a price elasticity of -0.53, based on elasticity estimates provided by the company model updated to the second quarter of 1987, should be used for intra-Bell customer-dialed MTS in the modelled off-peak period.

The Commission notes the difficulties encountered by the company in developing elasticity estimates for TransCanada MTS. In the absence of reliable current estimates, the Commission is prepared, for the purposes of this decision, to accept the estimates filed in response to interrogatory Bell(CRTC)20Mar87-715.

For the purposes of this decision, the Commission is also prepared to accept the relationships between elasticities for customer-dialed MTS and operator - handled MTS, WATS and 800 Service that are described in response to interrogatory Bell(CRTC)20Mar87-711.

5) Model Methodology Review

Noting that the elasticity estimates considered in rate proceedings are a direct function of the method used to estimate the demand/rate relationship for carriers' services, and that the technical issues raised by interveners on the topic of price elasticity in rate proceedings have become increasingly complex, the Commission considers it desirable to initiate a separate public process, whereby the Commission will review the methodology used by carriers and monitor carriers' research progress in developing quantitative models of demand. The Commission believes that such a public process will increase the amount of information available, afford an opportunity for interested parties to express their concerns more fully and provide greater assistance to the Commission in ruling upon an appropriate methodology for the estimation of price elasticities.

The public process will include one or more review meetings during which the Commission, carriers and interested parties can discuss, in a context less formal than a revenue requirement proceeding, their views on matters pertaining to the carriers' demand models. Both Bell and B.C. Tel will be directed to participate in this public process, further details of which will be contained in a public notice to be issued shortly.

B. Operating Revenues

1) Introduction

Traditionally, Bell's annual budget process involves the preparation, beginning in mid-summer, of a January View. This View includes two-year forecasts of demand and revenue. In 1987, the company's normal budget process was shortened because of the scheduling of the present proceeding. This abbreviated process, undertaken during the summer of 1987, resulted in a July Management Plan (JMP) containing the company's demand and revenue forecasts for 1987 and 1988. These forecasts were provided in the 10 August 1987 Memoranda of Support. The JMP assumed that the interim rates that came into effect on 1 July 1987 would be withdrawn as of 1 April 1988. On the basis of this assumption, the company forecast operating revenues of $6,134 million and $6,567 million for 1987 and 1988, respectively.

The company's forecasting models were not employed to the normal extent in deriving the base revenue forecast. However, the company's econometric elasticity models, discussed in the previous section, were extensively employed and played an unusually important role in formulating the revenue forecasts for 1987 and 1988 contained in the JMP. These models were employed to estimate, for the years 1987 and 1988, the stimulation/curtailment effect on revenues of (i) the rate reductions, effective 1 January 1987, ordered in Decision 86-17, (ii) the interim rate changes which took effect 1 July 1987, (iii) the rate reduction of approximately 13.5% on Overseas Long Distance Message Service which took effect 1 January 1988, and (iv) the proposed 10% federal sales tax on telecommunications services, effective 1 January 1988, announced in the government's 18 June 1987 White Paper on Tax Reform.

On 14 October 1987, the company filed Bell Exhibit 1, which outlined the current status of its JMP. The company explained that unexpected strength in the Canadian economy, particularly in central Canada, had led it to revise upwards some of its forecasts of key economic indicators. However, the company was of the opinion that most of that additional economic strength had occurred during the first half of 1987 and that the JMP's economic outlook for the fourth quarter of 1987 and for 1988 should remain unaltered. Thus, according to the company, the additional strength in the economy had already been reflected in the JMP. As a result, the company still considered the JMP to be a reasonable reflection of demand and revenue for 1987 and 1988. In Bell's opinion, therefore, no formal revision of the JMP forecast was warranted.

For the purpose of determining the 1988 revenue requirement, the Commission has used as its initial point of reference, the forecast provided in response to interrogatory Bell(CRTC)16Oct87-4401. This forecast was based on the JMP, but made the further assumption that the interim rate changes that took effect on 1 July 1987 would remain in effect for the whole of 1988. In response to interrogatory Bell(CRTC)13Nov87-4402, the company revised its revenue settlement calculations to incorporate a degree of detail not possible in the original JMP. The resulting estimate of Long Distance Service Revenues for 1988 was approximately $6 million higher than previously forecast. Based on the calculations performed in the responses to interrogatories Bell(CRTC)16Oct87-4401 and Bell(CRTC)13Nov87-4402, the company estimated that its total operating revenues in 1988 would be about $6,526 million.

During the proceeding, some interveners (specifically, Ontario, CBTA et al, CAC and NAPO) raised concerns related to the company's revenue forecasts. These concerns are addressed below.

2) Current Status of the JMP

Ontario, CBTA et al and NAPO argued that the JMP forecasts of 1987 and 1988 operating revenues should be revised upward in recognition of the higher forecasts of key economic indicators contained in Bell Exhibit 1, which provided the current status of the JMP. In support of this position, Ontario and others argued that it is difficult to understand how a significant improvement in the forecast for housing starts, together with an improvement in other economic indicators, does not result in an improvement in the forecast for demand and revenues. In addition, CBTA et al observed that Bell's forecasts in recent history have been characterized by an underestimation of revenues.

In its argument, Bell reiterated the position it had taken in Bell Exhibit 1. It stated that most of the additional economic strength had occurred during the first half of 1987. The company reasoned that, since the JMP was based on actual revenues up to the end of May 1987, the impact of this increased activity was built into the actual demand and revenue data for that period. According to the company, the fact that actual revenues to October 1987 were tracking the JMP very closely, provided a further indication that the full impact of the increased economic activity had been captured in the JMP. Bell also stated that any increase in NAS net gain that might occur during 1988 because of increased housing completions would be offset by reductions in NAS net gain due to higher apartment vacancy rates.

The Commission notes that, in the preparation of the JMP, Bell has placed less weight than usual on forecasting models that are based on key economic indicators and has relied more heavily on estimates prepared in the bottom-up forecasting process. Upward revisions to the key economic indicators therefore, have a correspondingly lesser impact on the JMP total revenue forecast than would normally be the case. The Commission recognizes that the abbreviated budget process necessitated by the scheduling of the present proceeding did not allow the company sufficient time to assess and revise the previously employed forecasting models. However, the Commission expects that, in future proceedings, the company will support its revenue forecasts by placing greater weight on forecasting models normally employed in the budget process.

With respect to Local Service and Long Distance Service Revenues, the Commission accepts the company's assertion that the JMP base revenue estimates capture the impact of the increased economic activity recognized in the current status of the JMP. Current tracking of the JMP forecasts of these revenues does not support the interveners' contentions that the more recent forecasts of the key economic indicators warrant an increase in the JMP forecasts of demand and base revenues.

3) Impact of 10% Federal Sales Tax

The White Paper on Tax Reform introduced by the Minister of Finance on 18 June 1987 contained a proposal to introduce a 10% federal sales tax on telecommunications services, effective 1 January 1988.

Both CAC and Ontario argued that it would be premature to reflect the curtailment effect of the proposed 10% federal sales tax on telecommunications services on the company's 1988 operating revenues. In support of this argument, CAC and Ontario suggested that there was some uncertainty as to whether or not the government would meet its scheduled 1 January 1988 implementation date. CAC recommended that the impact of the proposed 10% federal sales tax on Bell's revenues be excluded from the 1988 revenue requirement. These parties suggested that the Commission wait until the tax reform proposals become law and then conduct a proceeding to determine their impact on all of the federally-regulated telecommunications carriers.

Bell gave several reasons for considering the impact of the 10% sales tax in estimating the company's 1988 revenues. First, the tax reform proposals include reduced income tax rates scheduled to take effect 1 July 1988. The overall impact on the company's 1988 Net Income is only $2 million. Secondly, there is every indication that the tax reform proposals will become law. Finally, proposals by the Minister of Finance that are essentially equivalent to a federal budget traditionally come into effect on the scheduled date, even though they have not yet been enacted.

The Commission notes that the Minister of Finance has tabled Notices of Ways and Means motions to amend the Excise Tax Act and the Excise Act, including those provisions related to the telecommunications services tax, proposing an effective date of l January 1988. Also, Bell notified subscribers in its January 1988 billing that it would start collecting the 10% sales tax on telecommunications services as of 1 January 1988. Under the circumstances, the Commission considers it appropriate to include the impact of this sales tax on the company's forecast of its 1988 revenues.

4) Non-Penetration Lines

In final argument, Ontario expressed concern regarding the company's ability to forecast the non-penetration line component of residential NAS net gain. Given the increasing importance of this component, Ontario urged the company to formalize its methods of forecasting these lines.

Bell stated that it had just recently identified non-penetration line gain as an issue. The company indicated that it had made much progress in developing forecasts of these lines in the past year. It hoped to continue this progress in the coming years. The company noted that the forecasting process is subject to constant review and change.

The Commission shares the concerns expressed by Ontario in reference to the company's ability to forecast the non-penetration line component of residential NAS net gain. Given the increasing importance of this component, the Commission considers that the company should provide additional details with respect to the process of forecasting non-penetration NAS net gain, including information regarding the difficulties experienced in capturing the proper data.

Accordingly, the Commission directs Bell to file, as a follow-up item and within 90 days of the date of this decision, a report which provides the following information:

(i) details of the methodology presently used for forecasting non-penetration lines within Québec and Ontario;

(ii) the company's estimate of the number of non-penetration lines in each of the years 1983-1988;

(iii) details of the reasons for the difficulties the company is experiencing in obtaining from its own records an actual count of non-penetration lines;

(iv) details of the modifications the company would have to make to its record-keeping systems in order to obtain an actual count of non-penetration lines; and

(v) details of the company's plans to revise its methods of forecasting non-penetration NAS net gain.

5) Miscellaneous Revenues

NAPO stated that Bell had under estimated its forecast of Miscellaneous Revenues for 1988 by some $125 million. NAPO arrived at this figure by using the average increase in Miscellaneous Revenues over the previous six years to project 1988 revenues.

Bell suggested that the revised forecasting methods it has adopted have now resulted in an improvement in its ability to predict the Sales Revenues component of Miscellaneous Revenues. It stated that NAPO's suggestion of a $125 million adjustment was based on a superficial and an entirely flawed analysis.

In support of its position, Bell pointed out that actual Sales Revenues up to the end of September 1987 exceeded the JMP estimate by only $2 million. Bell suggested that this small variance did not justify an adjustment to its Miscellaneous Revenues forecast.

The Commission notes that, due to an apparent inability to properly fore cast Sales Type Lease (STL) Revenues, Bell has continually underestimated Miscellaneous Revenues in recent years. The Commission notes further that, during examination by Commission counsel, Dr. Dale Orr, Bell's Chief Economist, stated that the revised methods of forecasting STL Revenues had resulted in an even greater exercise of judgment in the forecasting of Miscellaneous Revenues. Furthermore, the Commission notes that actual 1987 results show that the JMP underestimated Miscellaneous Revenues for that year by approximately $15 million. This was primarily due to Sales Revenues, which exceeded the JMP estimate by $11 million.

As a result, the Commission remains unconvinced that the company has adequately forecast its Miscellaneous Revenues for the year 1988. However, the Commission does not agree with NAPO's suggestion that Miscellaneous Revenues be increased by some $125 million based on the average increase over the previous six years. The major cause of the Miscellaneous Revenues forecast variances in recent years has been unforeseen increases in Sales Revenues. The Commission notes that the rate of increase in Sales Revenues has been continually decreasing in recent years. Accordingly, the Commission is prepared to accept Bell's argument that Sales Revenues are approaching a level of maturity. The Commission is of the opinion that Sales Revenues in 1988 will at least maintain their 1987 level.

In light of the above considerations, the Commission finds an upward adjustment in the Miscellaneous Revenues forecast of some $15 million in 1988, attributable primarily to STL Revenues, to be reasonable. The related increase in expenses has been taken into account in the calculation of the company's revenue requirement for 1988.

6) Conclusions

Based on the evidence in this proceeding, the Commission has concluded that the company's JMP base revenue forecasts of Local Service and Long Distance Service for the year 1988 are reasonable. However, as discussed earlier in this part of the decision, the Commission has concluded that, generally, higher elasticity coefficients than those used by Bell in its JMP forecast are appropriate for the purpose of estimating Bell's 1988 revenues. The net impact of incorporating these higher elasticity coefficients is to increase the JMP forecast of 1988 revenues by about $18 million, assuming that interim rates remain in effect for the whole year.

Taking into account the above-noted adjustment and the higher estimate for Miscellaneous Revenues, the Commission has estimated the company's total operating revenues, assuming that interim rates are in effect for the whole of 1988, to be some $6,560 million in 1988.

C. Operating expenses

1) 1987 and 1988 Forecasts

In its Memoranda of Support, Bell estimated that its operating expenses for 1987 would be $4,499 million, representing an increase of 6.1% over 1986 expenses. For 1988, operating expenses were estimated to be $4,856 million, representing an increase of 7.9% over forecast 1987 expenses. When the effect of accounting changes is excluded, the forecast increases for 1987 and 1988 are 6.8% and 8.2% respectively.

The Commission notes that, in Bell Canada - Accounting for Real Estate, Telecom (Decision CRTC 88-3), the company's proposed accounting refinement with respect to real estate expenditures was denied. This has the effect of reducing the operating expense forcast for 1988 by approximately $26 million.

In its Memoranda of Support and in response to interrogatories, Bell provided details of the 1987 and 1988 forecasts by categories of expense, and further identified the forecast increases in terms of the reasons for the increase, i.e., price changes, workload (growth in demand), accounting changes and other.

The company also provided various measures of its operations performance, including its index of total factor productivity, employees per 1000 NAS, various components of expense per NAS, and other specific indicators such as operator services expense per operator handled call.

While recognizing that the value of these broad indicators of performance is, for various reasons, limited, the Commission notes that, with the exception of business office expense per NAS, all of these indicators point to continuing performance gains in 1987 and 1988, although at a marginally lower level than for recent years. With respect to the business office expense indicator, Bell explained that the lower forecast performance for 1987 and 1988 was related to the completion of the first phase of the business office mechanization project, combined with the need for additional resources to deal with the problem of an increase in uncollectible revenues.

NAPO, in its argument, was critical of Bell's expense forecasts for 1987 and 1988, stating that it was concerned with the ongoing ability of Bell to control its operating expenses, that Bell intentionally inflates its forecasts in the expectation that they will be reduced (similar to "a labour union's first proposals to management in the process of negotiating a collective agreement"), and that the evidence was superficial, particularly in explaining the reasons for the various forecast increases.

NAPO took the position that any increase in expenses of more than half a percentage point above the CPI must be regarded with some suspicion. NAPO submitted that little, if any, harm would be done to Bell or to its subscribers if its proposed increase in operating expenses (for 1988) were reduced by approximately $142 million, representing an increase of 5% compared to the current projection for the CPI of 4.5%.

Bell argued in reply that, even in making the broadest percentage comparisons, it is unreasonable to ignore growth in demand in forecasting expense increases. It noted that, if the increase in NAS of 4.7% were added to the projected CPI of 5%, the total increase in demand would be 9.7% for 1988, compared to its forecast percentage increase in expenses, excluding accounting refinements, of 8.2%. Bell thus argued that, contrary to NAPO's argument, the company will continue to experience productivity gains and actually achieve cost savings in 1988 in real terms.

In regard to NAPO's allegations that the company failed to adequately support or explain various expense increases, Bell noted that NAPO did not ask one single interrogatory concerning any expense item, neither did it ask one single question of the company's expense witnesses during the hearing.

The Commission agrees with Bell that the NAPO arguments were generally unsupported and finds them unhelpful with respect to the reasonableness of the company's expense forecasts for 1987 and 1988.

2) Vehicle Maintenance Expense

During cross-examination of Bell's panel of witnesses on operating expenses, CAC introduced CAC Exhibit 23 to support its argument that, on average, Bell's annual vehicle maintenance expense per vehicle is 33% higher than the corresponding expense of B.C. Tel. In responding to CAC's questions on this subject, Bell stated that, following the 1987 CPR meeting at which this subject was first raised, it had conducted a review of its vehicle maintenance expense in relation to B.C. Tel's. Bell noted that during this review, which included discussions with the National Association of Fleet Administrations, it found that expense per vehicle kilometre, rather than annual expense per vehicle, was a more meaningful and accepted measure of vehicle maintenance expense in the industry.

Bell stated that, after checking further with B.C. Tel, it found that its kilometres per vehicle were 28% greater than B.C. Tel's, and that this factor, together with certain other differences in accounting for vehicle expenses, explained the difference in annual expense between the two companies.

CAC also questioned Bell as to why it did not maintain three specific vehicle maintenance control indicators that are used by B.C. Tel and Pacific Bell, namely, motor vehicle uptime, monthly road calls per 100 vehicles and trouble reports per 100 vehicles. Bell stated that it had reviewed the potential usefulness of these three indicators with its fleet managers and had determined that the second and third indicators referred to do not appear to serve any useful purpose in terms of fleet management or expense control. It further stated, however, that a variation of the first indicator, motor vehicle downtime, was considered to be a useful statistic and that it would be introduced as a standard measurement within the company.

In argument, CAC submitted that Bell's testimony was contradictory, suggesting that it is inconsistent for Bell's fleet age to be 13% less than B.C. Tel's if its fleet mileage is 28% greater. CAC submitted that Bell should be directed to file a report aimed at resolving this contradiction and to compile and analyze, on a corporate level, the three maintenance control indicators referred to earlier.

In reply argument, Bell submitted that the CAC argument (that the company's evidence was contradictory) was incomprehensible. Bell stated that it is perfectly logical for its annual motor vehicle expense (per vehicle) to be higher than B.C. Tel's when the number of kilometres driven is higher, and that this is also consistent with its fleet age being 13% less than B.C. Tel's. Bell also reiterated its earlier position that motor vehicle downtime, a variation of motor vehicle uptime, was the only useful indicator, and that this indicator had now been introduced within the company.

The Commission considers that Bell has satisfactorily explained the difference between its annual expense per motor vehicle and that of B.C. Tel. The Commission notes that the company has introduced the motor vehicle downtime indicator and considers that the introduction of the two additional indicators is not required.

3) Marketing and Development Expense

Noting that Bell's competitive revenues per Marketing and Development employee have decreased from $2,099 in 1983 to $1,799 in 1986, CAC submitted that Bell has devoted too many resources to Marketing and Development activities in relation to the increase in revenues for competitive services. CAC requested that the Commission exclude from the revenue requirement increases in Marketing and Development expenses which exceed increases in competitive revenues.

In reply argument, Bell stated that it is inappropriate to measure Marketing and Development expenses against competitive services only, since these expenses are associated with all of the services provided by the company, including monopoly services. Bell cited as an example its recent television advertising campaign promoting long distance services.

Bell noted that, as explained during cross-examination, the increases in Marketing and Development expenses have, in large part, resulted from the transfers of various groups to the Marketing and Development organization. CAC's analysis, stated Bell, reflected the transfer of only one of these groups. Bell further submitted that the more relevant comparison is between Marketing and Development activities and total company revenues and that, on this basis, the revenue per employee has grown from $2.1 million in 1982 to a forecast $2.4 million in 1988, notwithstanding the growth in the number of employees and the 20% reduction in toll rates.

The Commission does not agree that increases in Marketing and Development expenses should necessarily be linked to increases in competitive service revenues alone. In this regard, the Commission notes that the ratio of Marketing and Development expense to total revenue, adjusted in accordance with the CAC analysis, has remained at a constant level over the period 1983 to 1986.

4) Uncollectible Revenues

CAC argued that Bell's uncollectible revenues are excessive and that this situation has occurred because of inadequate administration by the company in this area. CAC submitted that Bell's revenue requirement should be adjusted by the amount necessary to reduce the monthly write-off to the level experienced in 1984, i.e., $1.9 million per month, as opposed to the $3.3 million per month assumed in the company's forecast for 1988.

During cross-examination and in its reply argument, Bell acknowledged that the increase in uncollectible revenues is a problem. While the company was of the view that the increase has, in part, been due to the reassignment of staff to serve unexpected demand requirements, it noted that other factors also contributed to the problem. Bell stated that the company takes this matter seriously and is taking all reasonable steps to deal with the problem.

The Commission notes that the company has increased its staff assigned to uncollectibles by 195 persons since September 1986, and accepts, at this time, the company's position that it is taking the appropriate action to deal with the high level of uncollectible revenues.

5) Access to Billing Envelopes by Outside Advertisers

In its argument, CAC stated that access to Bell's billing envelopes by outside advertisers offers the opportunity to generate profits and thus reduce the rates for telephone service. CAC requested the Commission to direct Bell to conduct a study of the benefits that could accrue to subscribers through lower rates by allowing outside advertisers access to billing envelopes.

In response to questioning on this subject, Bell noted that a) the billing envelope is full in about 10 of the 12 annual billing periods, b) its consumer advisory panel had strongly recommended against providing this type of service, and c) while no formal study had been conducted, the company had recently examined the potential benefits of such a service and concluded that any revenues would likely be offset by expenses associated with the administration, selection and screening of advertising inserts. Bell also noted that a number of Bell operating companies in the United States had been offering this service, but had discontinued it for the reasons stated above.

In its reply argument, Bell referred to the explanation of its position in this matter that it had given during cross-examination, and submitted that the record provides no support for the CAC request.

In the Commission's view, in light of the evidence presented by Bell in this proceeding, the expense associated with further study of this matter is not warranted.

6) Conclusions

The Commission is satisfied that Bell's estimate of its operating expenses for 1987 and 1988 is reasonable. In making this determination, the Commission notes that actual expenses to the end of September 1987 were closely tracking the JMP forecast, and that the rate of increase for both 1987 and 1988 is less than the combined increase in projected prices and demand for the company's services.

The Commission notes, however, that the performance gains projected by the company for 1987 and 1988 are lower than those achieved over the past few years. While recognizing the circumstances underlying this lower performance, the Commission nevertheless expects the company to continue its efforts toward additional operational improvements. In this regard, the Commission notes that, by approving rates designed to achieve the mid-point of the allowed rate of return range in the test year, it provides the company with the means to enhance its return to shareholders through additional efficiency improvements.

V INTERCORPORATE TRANSACTIONS

A. Compensation for Temporarily Transferred Employees

1) Background

In Decision 86-17, the Commission determined that the appropriate compensation for employees temporarily transferred to Bell Canada International Inc. (BCI) was a 25% contribution calculated on an imputed cost comprising the aggregate of the annual salary and the labour related costs of each such employee immediately prior to transfer. It was also determined that these costs should be adjusted, where applicable, for any normal salary increases during the period of transfer, but should not include any salary adjustments attributable solely to an overseas posting.

In its 10 August 1987 Memoranda of Support, Bell noted that, in order to reflect the Commission's decision, it had made an adjustment to its 1985, 1986 and 1987 financial results reported for regulatory purposes. However, in accordance with the arrangements previously concluded between Bell and BCI, the company was continuing to charge BCI a one time fee of $700 per employee, as well as an annual $1,000 per employee fee. The company noted that the JMP for the year 1988 reflected these fees.

Bell stated that it had engaged Touche Ross & Co. (Touche Ross) to provide an opinion with respect to the level of fees required to fully compensate Bell for the 1988 direct and indirect costs related to the temporary transfer of employees. The company noted that, in a letter dated 9 April 1987, Touche Ross had concluded that the existing fees charged by Bell fully compensated Bell for costs incurred in relation to the transfers.

Bell also stated that, in a letter attached to its Memoranda of Support dated 14 July 1987 and addressed to Mr. A.J. de Grandpré, Chairman of BCE Inc. (BCE), formerly Bell Canada Enterprises Inc., the Minister of Communications had indicated, in effect, that the level of compensation for regulatory purposes should not exceed the audited costs directly and indirectly associated with these transfers.

In a letter to the Commission dated 9 October 1987 and filed as CRTC Exhibit 2, the Minister of Communications stated that the remarks in her letter of 14 July 1987 did not instruct the Commission on how to deal with the transfer of revenues between Bell and BCI. The letter also stated that it was not the Minister's intention to leave the impression that the determination of the value of these transfers should be restricted to the use of accounting costs.

In a letter dated 19 October 1987, Bell advised the Commission of revisions to the manner in which BCI is charged for temporary transfers. Effective 1 November 1987, the one time fee of $700 was replaced by separate and distinct fees for a) each employee accepted by BCI, b) each employee repatriated to Bell from special leave of absence to BCI, and c) each extension of the term of any special leave of absence for an employee temporarily transferred to BCI. As of 1 January 1988, these fees were raised to $1840, $455, and $90, respectively. The annual fee of $1000 per employee would continue to be charged to BCI.

A copy of a letter from Touche Ross to Bell, dated 8 October 1987, was attached to Bell's 19 October 1987 letter. In its letter, Touche Ross expressed the opinion that the fees proposed for 1988 should be adequate to compensate Bell for all costs to be incurred for 1988, assuming that there was no significant change in the activities involved.

2) Positions of Parties

Bell argued that a Commission finding on this issue similar to that in Decision 86-17 would be inappropriate. It noted that, in that decision, the Commission deemed the contract between BCI and the kingdom of Saudi Arabia (the Saudi contract) to be non-integral. Bell stated that, in so doing, the Commission recognized that neither the risks nor the benefits of such ventures should be borne by subscribers and that the issue is solely one of appropriate compensation for temporarily transferred employees. In Bell's view, the Commission should focus on ensuring that monopoly subscribers are not called upon to cross-subsidize any portion of BCI's international ventures.

The company stated that it had taken careful measures in order to be in a position to demonstrate clearly that all costs are being, or will be, recovered from BCI. It stated further that the new fee structure was designed to recover the costs related to the temporary transfer of employees, plus a contribution of 25%, plus a $1000 annual fee. While Bell acknowledged that the compensation arising from the new fee structure was not of the same magnitude as the 25% contribution on imputed costs prescribed by the Commission in Decision 86-17, the company submitted that this fee structure would ensure that there was no cross-subsidy by subscribers.

Bell stated that it is virtually impossible to determine a fair market value for the services it provides to BCI, and that there is no evidence that the company does not receive at least as much as other companies would receive in similar circumstances. The company suggested that the Commission should take into account the particular effect on BCI of the pricing structure prescribed in Decision 86-17. According to the company, there is evidence that BCI is experiencing serious difficulties in the international marketplace. Bell noted that the Saudi contract was renewed for a one-year period only, and that it cannot be presumed that the renewal was made at the same rates or terms.

Ontario, CBTA et al and CAC addressed this issue. All expressed the view that the regulatory treatment set out in Decision 86-17 continues to be appropriate.

In the view of CBTA et al, a number of benefits that were paid for by Bell's subscribers are being provided by the company to BCI. These benefits include: a) the expertise in telecommunications developed over the years by Bell employees; b) the goodwill associated with the quality of Bell employees; c) the fees saved by using Bell employees instead of having to use a "head-hunter" firm to hire employees; d) the job guarantee provided to high quality Bell employees, without which highly skilled employees might be unwilling to take the risk of working for an international consulting firm; and e) the flexibility of being able to return employees to Bell when work is slow and bring them back again as required. Since these benefits have nothing to do with audited costs, CBTA et al submitted that the audited costs are not relevant.

CAC argued that the only circumstance that has changed since Decision 86-17 is the mix of recruited, extended and repatriated employees. Since this change is a technical or administrative matter that does not bear directly on the appropriate regulatory treatment, CAC believes that the treatement considered appropriate in Decision 86-17 continues to be appropriate. CAC stated that nothing, in effect, has changed.

CAC expressed the view that the Touche Ross audit, the results of which were reported to Bell in the letter dated 8 October 1987, was not adequate for regulatory purposes. CAC noted that the Canadian Institute of Chartered Accountants (CICA) considers it highly desirable that an auditor obtain an engagement letter from a client. CAC was critical of Touche Ross for failing to obtain such a letter. A witness from Touche Ross replied that a letter had not been considered necessary since the terms of the engagement were fairly clear. In CAC's view, the terms of the engagement were not clear. According to CAC, the role of Tele-Direct (Publications) Inc. (Tele-Direct), which, for regulatory purposes, is treated as an integral part of Bell, should have been clarified in the engagement letter. CAC noted in this regard that Tele-Direct is not compensated for the transfer of employees to BCI, and proposed that Tele-Direct be compensated, for regulatory purposes, on the same basis as Bell.

CAC argued that the risk of not finding enough work for its employees, a risk that would otherwise be borne by BCI, has been transferred from BCI to Bell by virtue of re-employment guarantees that give BCI the ability to send employees back to Bell. CAC suggested that the compensation ordered by the Commission in Decision 86-17 could be considered, in effect, an insurance premium for the assumption of the risk associated with the re-employment guarantee.

In reply argument, Bell stated that Touche Ross had a clear understanding of the terms of its engagement and that those terms were reflected accurately in the reports. Bell noted that Touche Ross had not considered the role of Tele-Direct since it had not been asked to do so.

Bell also expressed the view that the Commission should not feel constrained by its finding in Decision 86-17, but should regard the matter in the light of the factors and developments outlined during this proceeding.

3) Conclusions

The Commission has not been persuaded that the approach to compensation for temporarily transferred employees prescribed in Decision 86-17 should be changed. Bell has chosen to address the question of whether a cross-subsidy exists solely on the basis of accounting costs. The Commission rejects this view and is of the opinion that accounting costs alone do not capture the full costs involved in temporary employee transfers to BCI. The Commission notes in this regard the Minister's letter, dated 9 October 1987, in which she stated: "... it was not my intention to leave the impression that the determination of the value of these transfers should be restricted to the use of accounting costs."

Among the costs not included in the accounting costs are those costs associated with the re-employment guarantees. The Commission finds persuasive CAC's argument that Bell, by virtue of these guarantees, absorbs a large part of the risk that BCI might, at some point, be unable to find sufficient work for its employees.

In Decision 86-17, the Commission noted that the company had been reasonably successful in achieving the traditional 25% contribution in connection with intercorporate transactions. In this regard, the Commission notes that when Bell employees are merely loaned to BCI, rather than being temporarily transferred, BCI compensation to Bell includes a 25% contribution on employee salaries and benefits, and that the approach adopted in Decision 86-17 is consistent with that practice.

In the Commission's view, the question of whether or not a cross-subsidy exists is best determined by reference to the fair market value of the goods or services being supplied. If Bell is supplying goods or services to a non-arm's length company at less than fair market value, it is subsidizing that company. The Commission realizes that fair market value is, in these circumstances, difficult to determine. However, there is nothing on the record of this proceeding to indicate that the proxy for the fair market value of temporarily transferred employees adopted in Decision 86-17 is not appropriate. In the Commission's view, difficulties BCI may be experiencing in the international marketplace do not provide sufficient justification for a departure from the Commission's policy that Bell subscribers should not be obliged to subsidize the competitive endeavours of Bell affiliates.

The Commission notes that Bell employees are now temporarily transferred to affiliates other than BCI, and that employees of Tele-Direct are also temporarily transferred to affiliates. The Commission has therefore determined that, for regulatory purposes, the compensation for any employee temporarily transferred from either Bell or Tele-Direct to any affiliated company shall be as prescribed in Decision 86-17. The Commission has adjusted the company's 1988 revenue requirement to reflect its decision regarding the annual compensation for temporarily transferred employees. The Commission estimates that, for regulatory purposes, this will increase the company's 1988 net income after taxes by about $4 million.

B. Procedures for Purchases from Affiliates Excluding Northern Telecom Canada Limited (NTCL)

1) Background

In Decision 86-17, the Commission found that inappropriate pricing could occur between Bell and an affiliated company in the absence of an objective and formal control procedure to ensure that Bell receives the best price possible. Accordingly, Decision 86-17 directed Bell to file procedures to ensure that the company's Intercorporate Pricing Policy for purchases from affiliates other than NTCL exceeding $500,000 annually was respected. Noting that it adopts different approaches depending on the market and circumstances in each case, Bell filed, on 12 January 1987, a brief description of each of the procedures it uses for dealing with affiliated suppliers.

In letters dated 11 February 1987, CBTA et al and CAC expressed the view that Bell's submission did not contain an objective and formal control procedure as required by Decision 86-17. They also expressed concern with the content of some of the procedures that were filed. In their opinion, it would be preferable to require the company to adopt a competitive bidding approach.

In a letter of response dated 26 February 1987, Bell argued that no single set of procedures can be appropriately devised to ensure that the company's Intercorporate Pricing Policy is respected. In Bell's view, the procedures outlined in its submission demonstrate that no inappropriate pricing occurs in its purchases from affiliated suppliers. Bell also suggested that, should the Commission consider competitive bidding as a potential solution to the problems associated with intercorporate purchases, the company should have a fair and adequate opportunity to deal with the full implications of such an approach before it was adopted.

2) Positions of Parties

Bell noted that the volume of purchases from affiliates is extremely small and that, in terms of its purchasing practices, the company does not distinguish between purchases from affiliates and purchases from non-affiliates.

The company again claimed that no single set of procedures can appropriately be devised to ensure that its Intercorporate Pricing Policy is respected. In Bell's opinion, different methodologies should be used in different situations.

In Bell's view, one cannot fairly conclude that its practices are not objective. Bell claimed that its practices provide the degree of flexibility necessary to ensure that the procedure adopted fits the particular circumstances of the case.

The Director expressed several concerns regarding this issue. In the Director's opinion, Bell ignored the fact that the procedures filed pursuant to Decision 86-17 were to be formal and objective. The procedures and criteria pertaining to cost comparison studies were often unwritten. In the Director's view, the words "formal and objective" in this context require that the procedure be written so that one can assess it and decide whether or not it is fair. In addition, the procedure must be consistently applied, so that one knows in all cases that affiliates and other purchasers or suppliers are being treated on an equal basis. In the opinion of the Director, the cost comparison studies were neither formal nor objective.

The Director suggested that "most favoured customer" clauses, while they may have some utility, are not the answer to concerns about affiliate pricing problems. As Bell conceded, such clauses would not be effective if Bell were the most favoured customer. It would be fair to infer, said the Director, that in many cases Bell would be a large customer, and perhaps the most favoured customer.

The Director also noted that Bell's competitive bidding process is not a tendering process. Instead, it is a process which identifies parties with which Bell then enters into negotiations.

In the Director's view, Bell should be asked to create new formal objective procedures to ensure fair pricing. One of these procedures should be a true tendering process leading to a contract. This true tendering process should be used in all cases where an affiliate is an actual or prospective supplier. The Director also proposed that, in instances where Bell deals with an affiliate which is not the lowest bidder or without a tendering process, the transaction should be reported in the quarterly intercorporate transactions report, together with an explanation.

In reply argument, Bell reiterated its claim that no single set of procedures can appropriately be devised to ensure that the company's Intercorporate Pricing Policy is respected. The company noted that, while CBTA et al, in its filing following the Decision 86-17 proceeding, had taken issue with the company's approach, it had agreed that no single set of procedures could ensure that the company's Intercorporate Pricing Policy was respected.

In Bell's view, the Director provided no basis on which the Commission could conclude that the company's current procedures do not ensure that it obtains the best price and terms possible in its purchasing practices. The company also believes that the Director has ignored the costs and disadvantages that would result from the implementation of his proposal.

The company suggested that, in the absence of any evidence that its practices have resulted in inappropriate pricing, it would be folly for the Commission to order the company to abandon a sound business approach.

3) Conclusions

The Commission has determined that Bell's filing in response to Decision 86-17 does not properly respond to the directive in that decision.

The Commission will shortly issue a public notice to initiate a proceeding to review Bell's practices regarding purchases from its affiliates other than NTCL. The Commission's aim is to ensure that the company secures the best terms possible in its purchases from affiliates, so that no burden is placed on Bell's subscribers. To this end, the Commission will seek comment on various possible procurement procedures, including a competitive tender process where an affiliate is an actual or potential supplier. The Commission will also seek comment on the advantages, disadvantages and implications of the use of the various procedures, as well as the circumstances and market conditions in which each should be applied. The proceeding will consider Bell's practices in relation to the acquisition of both goods and services from affiliates, including its arrangements with Bell Technical Services Inc. concerning Dataforce activities.

C. Transfer of Assets

The Director noted that Decision 86-17 directed that assets with a readily ascertainable fair market value, such as real estate and buildings, are to be transferred at that value; and that where it is neither feasible nor practical to determine the fair market value of assets, as in the case of assets such as plant and equipment, the assets are to be transferred at net book value. The Director contended that Bell's evidence shows many instances where book value is used, even though the fair market value is known. In the Director's view, fair market value should be used in all cases where it is readily ascertainable. Any exceptions to this rule should be explained in the quarterly intercorporate transactions report.

Bell contended that the values at which assets are transferred are in compliance with the directive in Decision 86-17.

The Commission notes that this type of transaction is reported in the quarterly intercorporate transaction reports and, as a result, the Commission may take any action in regard to them that it considers necessary.

VI DEFERRED TAX LIABILITY

A. Background

The White Paper on Tax Reform introduced by the Minister of Finance on 18 June 1987 contained a proposal to reduce the federal corporate income tax rate for general business from 36% to 28%, effective 1 July 1988. The Commission notes that the Minister of Finance has now tabled a Notice of a Ways and Means motion to amend the Income Tax Act.

Bell has estimated that the balance of the company's deferred tax liability, which the company will eventually have to pay, would be $310 million lower at 31 December 1988 if this accumulated tax liability were adjusted to reflect the reduced corporate income tax rate proposed in the White Paper.

B. Positions of Parties

Ontario, Québec, CBTA et al, CAC and NAPO addressed this issue. With the exception of NAPO, all of these parties were in favour of the Commission holding a separate proceeding to deal with the question. It was NAPO's position that it would be preferable for the Commission to issue a contingent order under Section 57(1) of the National Telecommunications Powers and Procedures Act. In NAPO's view, such an order would save the parties the expense of another proceeding.

In Bell's opinion, the reduction of income tax rates and the appropriate accounting treatment for deferred income taxes are two separate and distinct issues. The company maintained that the scheduled 1988 income tax rate reductions do not result in or cause either an adjustment to the deferred tax liability or a change in the method of calculating the deferred tax liability.

Bell noted that the CICA is currently examining this issue. Bell is of the view that, should the CICA decide that a deferred tax liability is to be measured on the basis of enacted tax law, it will also examine the question of the appropriate period over which to bring resulting changes in deferred tax accounts into income. The company also expressed the opinion that the issue is simply an accounting issue with which the Commission can deal at any time, and that if the issue is dealt with as an accounting issue, no problem of retroactivity occurs.

In reply argument, Bell noted that it would not, under present circumstances, be able to flow any credit arising from a reduction in the deferred tax liability through the income statement to shareholders. It noted that such an action could only be achieved if its current accounting treatment were changed. As prescribed in Decision 86-17, at pages 46 and 47, such a change would require the approval of the Commission.

Bell expressed the view that it would be desirable for the Commission to hold a separate proceeding at such time as the parties were in a position to be of better assistance to the Commission.

Bell suggested that such a proceeding only take place after the issuance of a CICA exposure draft indicating the possibilities under serious consideration. Bell noted that the procedure it suggested did not result in the company being singled out from among other Canadian corporations for a different or unusual accounting treatment for such an important item.

C. Conclusions

The Commission has determined that it will deal with the subject of deferred tax liability in a separate proceeding. In arriving at its decision, the Commission notes both the potential magnitude of excess deferred tax liability and the fact that all federally-regulated carriers will be affected.

The Commission recognizes that postponing consideration of this matter may increase the amount of information available to parties and contribute to a more complete discussion of the issues involved. However, in fairness to subscribers, the Commission considers that this question should be resolved expeditiously, preferably in time to permit a 1989 implementation date. Accordingly, the Commission expects to issue a public notice in the near future announcing the proceeding. Any CICA exposure draft issued in time will be considered, along with the comments of all the parties.

VII FINANCIAL CONSIDERATIONS

A. General

Based on the company's JMP, which assumed that the interim rates that came into effect on 1 July 1987 would be withdrawn as of 1 April 1988, the company anticipated a 1988 rate of return on common equity (ROE) of 13.0% on a regulated basis. The 1988 ROE estimate included a deemed 15.38% after-tax return on Bell's average investments in non-integral subsidiary and associated companies. As discussed in Part IV of this decision, the company outlined the current status of its JMP in Bell Exhibit 1. Based on this current status, the company still considered its JMP to be a reasonable reflection of the company's demand and revenue for 1988. The company concluded that no revision was required to the JMP budgetary forecasts for 1988 and still anticipated an ROE of 13.0% for 1988.

Bell engaged two expert witnesses, Dr. Stephen F. Sherwin (assisted by Mrs. Kathleen C. McShane) of Foster Associates, Inc., and Dr. Roger A. Morin of Georgia State University, to prepare evidence as to a fair and reasonable rate of return on common equity for the company. In the written evidence submitted as part of the company's Memoranda of Support, Dr. Sherwin recommended an allowed rate of return range of 12.75% to 13.75%, while Dr. Morin recommended a range of 13.5% to 14.0%.

Because of illness, Dr. Sherwin was unable to present oral evidence at the hearing. His colleague, Mrs. McShane, appeared in his stead. Mrs. McShane testified that changes in financial market conditions since the preparation of the written evidence warranted an emphasis on the upper end of the recommended rate of return range. Dr. Morin, in his oral testimony, concurred with Mrs. McShane in this respect. In its Memoranda of Support, Bell stated that a fair ROE for Bell should be in the range of 12.75% to 14.0%. However, in final argument, Bell stated that a fair rate of return estimate based on current conditions would not place the lower end of the range as low as 12.75%. (The evidence of the ROE witnesses will be discussed in greater detail in the portion of this decision dealing with rate of return, infra.)

Bell's witnesses stressed the importance of the company maintaining a double-A credit rating for its debt securities, as assessed by the two major U.S. rating agencies, Moody's Investors Service, Inc. (Moody's) and Standard & Poor's Corporation (S&P). Bell considered this rating essential in order to ensure the company's access to global financial markets at reasonable rates. Bell pointed out that it requires a high level of external financing, specifically, over $1 billion for each of 1987 and 1988, and that in 1988 it will be required to raise some $675 million in long term debt. This high level of external financing is needed in order to fund Bell's construction program, which is expected to reach record high levels in coming years because of continued strong demand for the company's services. In addition, the company would be required to refinance maturing debt.

Bell stressed that, in international financial markets, the credit ratings assigned by Moody's and S&P are crucial. Bell stated that its objective is to gradually improve its position in relation to the minimum financial requirements necessary to maintain its double-A rating. The company considered that the achievement of the financial performance projected in the JMP for 1987 and 1988 should be adequate to alleviate investors' concerns and would result in financial ratios in line with double-A benchmark requirements for debt investors.

Bell engaged Mr. Robert E. Bellamy of Burns Fry Limited to present evidence on the company's position in the Canadian financial market, and Mr. Robert H. Hanson of Merrill Lynch, Pierce, Fenner & Smith, Inc., to present evidence on the U.S. investor's perception of Bell's financial position and on Bell's position in international financial markets. The evidence they presented was similar to that presented in the proceeding leading to Decision 86-17.

Mr. Bellamy noted the limited size of the Canadian financial market and the extent of Bell's need for external financing. He testified as to the importance of Bell guarding its financial reputation if it were to maintain access to international sources of financing. He pointed out that the Dominion Bond Rating Service (DBRS), a major Canadian rating agency, had recently downgraded Bell's Debentures and First Mortgage Bonds. The Canadian Bond Rating Service (CBRS), Canada's other major rating agency, had expressed certain concerns about the company in the wake of Decision 86-17. Mr. Bellamy noted that S&P had also downgraded Bell. He stressed that, as a result of these and other factors, it is essential that Bell maintain sound financial ratios. He pointed out that Bell's debt ratio had improved to 44.5% as of the end of 1986, and expressed the opinion that, in view of Bell's financing requirements, it would be preferable if this ratio continued to improve. He also believed that Bell's year end 1986 interest coverage of 4.1 times should be maintained.

Mr. Hanson submitted that Bell's ability to meet its financing requirements at reasonable rates and with sufficient flexibility depends upon the company's ability to access international financial markets. This ability depends upon the company maintaining its double-A credit rating. Mr. Hanson expressed the opinion that recent improvements in Bell's financial ratios could be jeopardized by a downturn in the economy or a reduction in the company's ROE. This could result in further downgradings in Bell's credit rating. He noted that Bell's financial performance has been surpassed in recent years by the performance of its peer group of American telephone companies. Many of these companies have been upgraded by the U.S. bond rating agencies. Bell Canada, on the other hand, has been downgraded by S&P.

Mr. Hanson noted that financial markets have recently become more volatile. In such conditions, he stated, it is particularly important that a capital intensive company such as Bell maintain a good credit rating. A further downgrading might mean that Bell would be required to pay higher interest rates. Mr. Hanson also stated that a downgrading would have additional consequences, which could include investors' demands for shorter maturities and other terms and conditions disadvantageous to the company.

Both CAC and NAPO engaged witnesses who presented evidence as to a fair and reasonable rate of return on common equity and an appropriate capital structure for Bell. Dr. Myron J. Gordon of the University of Toronto and Dr. Laurence I. Gould of the University of Manitoba testified on behalf of CAC; Dr. Michael K. Berkowitz and Dr. Laurence D. Booth, both of the University of Toronto, appeared for NAPO. The evidence concerning rate of return is discussed below in the section dealing with that topic.

In their submissions concerning Bell's capital structure, CAC's witnesses argued that Bell's debt ratio should not be decreased. Since debt capital is cheaper than equity capital, a decrease in the debt ratio would raise the company's overall cost of capital. Consumers would be called upon to pay for these increased costs. They argued that, because a lower debt ratio results in a decrease in the risk to shareholders, the management of a regulated firm will always seek to lower the company's debt ratio to the furthest extent acceptable to the regulator. They were of the opinion that a capital structure of 50% debt, 5% preferred equity and 45% common equity, combined with an ROE of 11.5%, would not jeopardize Bell's access to financial markets. However, they would find Bell's existing capital structure acceptable if the company's ROE were lowered to 11.5%.

NAPO's witnesses also suggested that Bell should be financed with a greater proportion of debt in its capital structure than is presently the case. They employed a regression model for assessing Bell's capital structure. Based on this model, and after comparing Bell's capital structure to that of a sample of Canadian telephone companies (telcos), they estimated that an appropriate debt ratio for Bell would be about 53%. In their opinion, it had not been demonstrated that an increase in Bell's debt ratio would lead to an increase in its cost of common equity.

In final argument, CBTA et al submitted that the Commission should not approve a decrease in the company's debt ratio. In CBTA et al's opinion, a downgrading of the company's present double-A rating would not jeopardize its ability to attract long term debt.

In reply, Bell noted that the CAC witnesses did not consider in their evidence the impact of a higher debt ratio on the required return on common equity. The savings brought about by the increased debt ratio suggested by the CAC witnesses must be set off against resulting increases in the cost of common equity. In addition, CAC had stated in final argument that Bell's capital structure was acceptable. In reply to NAPO's arguments, Bell questioned the regression analysis performed by Drs. Booth and Berkowitz in attempting to determine an appropriate capital structure for the company. Bell also questioned NAPO's evidence concerning the relationship between the level of debt and the cost of common equity. In general, stated Bell, a higher debt ratio would produce no tangible benefits for consumers, while jeopardizing the company's ability to access financial markets on reasonable terms.

B. Rate of Return

1) Summary of Evidence

Dr. Sherwin's recommended ROE range of 12.75% to 13.75%, presented in his written evidence of August 1987, was based on the application of the comparable earnings, discounted cash flow (DCF) and risk premium methods. Dr. Sherwin used an approach to estimate ROE that is similar to the one he presented in the proceeding leading to Decision 86-17. Dr. Sherwin arrived at his ROE recommendation by giving 50% weight to the result of the comparable earnings method and 50% weight to the median result of the two measures of the cost of attracting capital. In arriving at his DCF estimates, Dr. Sherwin adjusted his "bare-bones" DCF cost of capital upward by about 50 basis points to allow for the recovery of flotation costs.

Dr. Morin's recommended ROE range of 13.5% to 14%, presented in his written evidence of August 1987, was based on the same three methods that Dr. Sherwin used. In his comparable earnings analysis, Dr. Morin relied on average realized returns for a group of selected industrials over a 10-year period (i.e., 1977 to 1986). In addition, Dr. Morin applied the DCF method to a group of six Canadian telcos and to a group of seven U.S. telecommunications companies.

Dr. Morin used a quarterly discounting model, instead of an annual discounting model, in arriving at his DCF estimates. As a result, his estimates were about 30 basis points higher. In estimating the growth rates for the Canadian sample companies, Dr. Morin relied on the same 10-year period that he used in his comparable earnings analysis. He then adjusted his "bare-bones" DCF cost of capital upward by about 50 basis points to allow for the recovery of flotation costs. Dr. Morin made three estimates of the cost of common equity using the risk premium method. One of these estimates was based on the same sample of U.S. telecommunications companies as was used in his DCF analysis.

In their written evidence of 20 November 1987, Drs. Gordon and Gould concluded that Bell's cost of equity capital was in the range of 11% to 12%, with a best estimate of 11.5%. This assessment was based on Bell's present capital structure of 46% debt, 5% preferred equity and 49% common equity. Although the capital structure differs, the ROE recommended by Drs. Gordon and Gould is identical to that recommended by Dr. Gould in the proceeding leading to Decision 86-17. Their approach was also similar to that presented by Dr. Gould in the proceeding leading to Decision 86-17. They applied the DCF method, using the sustainable growth approach, to data on BCE and on a group of Canadian telcos. They did not adjust their "bare-bones" DCF cost of capital upward to allow for the recovery of flotation costs. In their view, flotation costs incurred should be treated as an expense and recovered in the revenue requirement. They did not perform a risk premium test to estimate a fair rate of return. However, they did calculate an after-tax risk premium based on their recommended DCF estimate. In addition, Drs. Gordon and Gould carried out an analysis of the flotation costs incurred by BCE/Bell for common equity raised between 1977 and 1986.

In their written evidence of November 1987, Drs. Booth and Berkowitz arrived at a recommended ROE in the range of 11.3% to 12.23%, with a best estimate of 11.83%, based on the application of the DCF and risk premium methods. Drs. Booth and Berkowitz used a DCF method similar to the one they presented in the proceeding leading to Decision 86-17. They did not include a flotation cost allowance in their DCF estimates. In addition, they carried out two studies using the risk premium method, examining both the spread over preferred yields and the spread over bond yields. The former estimated the relationship between the logarithm of the market-to-book ratio and the spread. This analysis was applied to BCE and to the sample of Canadian telcos. The latter examined the relationship between the experienced return and the yields on different debt instruments between 1957 and 1986.

In their written evidence, Drs. Booth and Berkowitz also criticized the evidence presented by Drs. Sherwin and Morin. In their opinion, Dr. Morin's evidence based on U.S. companies was irrelevant. They arrived at this conclusion through an examination of the tax structure, equity yields and after-tax risk premiums in Canadian and U.S. financial markets.

In argument, Ontario suggested that the currently approved range is adequate and that the evidence does not warrant any changes, and CBTA et al stated that Bell should be allowed an ROE not exceeding a range of 11.5% to 11.8%.

Many questions were raised at the hearing concerning the methods employed by the witnesses and the application of those methods. Interveners questioned the choice of methodologies, risk measures, representative samples, data series and time periods utilized by the company's witnesses. The company compared the evidence presented by the interveners' witnesses to the evidence those same witnesses had presented during the proceeding leading to Decision 86-17. It noted inconsistencies and, on this basis, questioned the reasonableness of the evidence submitted by the interveners' witnesses. Rate of return issues raised by parties on which the Commission wishes to comment are set out below.

2) Comparable Earnings Method

As in the proceeding leading to Decision 86-17, interveners raised concerns about the relevance of the comparable earnings method. Ontario, CAC and NAPO stated that, although the fairness notion of the comparable earnings method meets the legal standard, it does not meet the capital attraction standard. The method is therefore inconsistent with the purpose of economic regulation. Ontario contended that the method appears to be entirely irrelevant to a determination of the cost of capital.

It urged that the results of the comparable earnings analyses conducted by both Drs. Sherwin and Morin be disregarded in their entirety. In Ontario's view, the method has fallen into disfavour in both the U.S. and Canada because of the conceptual problems associated with an accounting based method.

CAC's principal objection to the comparable earnings method is that the rates of return of unregulated companies are not relevant to the determination of an allowed rate of return for a public utility. CAC urged the Commission to give no weight to results based on this method. NAPO noted that, although there is some judgment in all methods, the comparable earnings method involves a much greater degree of judgment than others.

CBTA et al urged the Commission to specify that a fair return must be based on the capital attraction standard. CBTA et al was of the opinion that this is necessary in order to prevent the future submission of evidence derived from the comparable earnings method.

In reply argument, Bell urged the Commission not to abandon the position it had taken in Decision 86-17 and in British Columbia Telephone Company - General Increase in Rates, Telecom Decision CRTC 85-8, 30 April 1985, that all three methods should be considered in assessing the fair rate of return. In particular, Bell asserted that all of the methods used involve a degree of judgment, and that none of them can be applied in a mechanical or purely mathematical fashion. The company contended that there are certain aspects of judgment required in the DCF method that are not necessary in the comparable earnings method. It pointed out that each method must be applied with great care and integrity, using expert and informed judgment. In addition, the company noted that the comparable earnings method is still very much in use by various regulatory bodies across North America, although bodies such as the U.S. Federal Energy Regulatory Commission have selected the DCF method as a result of generic proceedings. Finally, the company contended that Dr. Sherwin had dealt with the shortcomings of the method by selecting a business cycle undistorted by high inflation.

The Commission agrees with the company that concerns about the comparable earnings method have been addressed in previous revenue requirement proceedings. The Commission noted in Decision 86-17 that, in general, it considered the various approaches used by the witnesses to be of assistance. In this proceeding, the Commission has considered the results of all three methods in assessing the fair rate of return. The Commission notes, however, that Dr. Sherwin has assigned a 50% weight to the result of his comparable earnings test. The Commission considers this emphasis excessive.

The Commission also has some reservations about Dr. Morin's comparable earnings analysis. In essence, the Commission agrees with Ontario and NAPO that the 10-year period used in his analysis was chosen on a basis that is inconsistent with economic theory. It includes two peaks and only one trough. Further more, a substantial portion of the time period is characterized by unusually high rates of inflation. For these reasons, the Commission found Dr. Morin's comparable earnings result to be of minimal assistance in establishing an ROE range for Bell.

3) Flotation Costs

Generally, the parties agreed that the company should be reimbursed for flotation costs incurred. They disagreed, however, on the magnitude of the costs, the method for awarding the costs, and the treatment of the associated tax benefits which accrue to BCE.

CAC, NAPO and CBTA et al argued that the company had not provided sufficient evidence to justify its requested flotation cost adjustment of 7% (about 50 basis points). They questioned the relevance of data based on studies of U.S. utilities. CAC and CBTA et al pointed out that the analysis performed by Drs. Gordon and Gould indicated that many sources of common equity either have no financing costs or costs much lower than 7%. They also submitted that no allowance should be made for the effects of market pressure. Drs. Booth and Berkowitz argued in their written evidence that BCE's decision to terminate its Dividend Reinvestment Plan (DRP) indicated that its flotation costs are less than 5%.

The company noted that both Drs. Morin and Sherwin recommended a flotation cost adjustment of 7%, although they used very different approaches in arriving at their respective conclusions. The company disputed the relevance of the analysis performed by Drs. Gordon and Gould, noting that i) flotation costs incurred prior to the 10-year period of the study had been excluded; and ii) Drs. Gordon and Gould failed to include costs associated with the DRP and with the issue of convertible preferred shares.

CAC stated that no adjustment should be allowed for the financing costs of past stock issues. CAC and CBTA et al recommended that direct costs, including underwriters' remuneration, should be treated as an expense in computing the company's revenue requirement. Drs. Sherwin and Morin both used the amortization method for the recovery of flotation costs.

CAC argued that, subsequent to the reorganization of the Bell group of companies, the tax benefits associated with flotation costs have accrued to BCE and not to Bell. If a flotation allowance were given, consumers would pay for flotation costs without receiving the benefit of the offsetting tax deductions. The company contended that CAC did not provide any evidence to substantiate the position that flotation costs should be treated on an after-tax basis.

The Commission agrees with the majority of the parties that flotation costs incurred are genuine costs and should be recovered. The Commission also agrees with all the interveners that the company did not provide sufficient evidence to support an award of 7%. In the Commission's view, based on the evidence presented, such an award would be excessive.

The company's witnesses placed great reliance on studies of U.S. public utility stock issued between 1963 and 1980. For the purpose of determining the allowance for market pressure, the Commission has concerns about the relevance and reliability of market pressure estimates derived from the U.S. studies. During examination by Commission counsel, Mrs. McShane agreed that, in addition to market pressure, these estimates could include the effect of other factors that influence stock prices. The Commission notes further that the analysis done by Drs. Gordon and Gould shows that much of the equity raised by BCE/Bell over the past 10 years cost far less than 7%.

In future revenue requirement proceedings where rate of return is under consideration, the Commission will accord little weight to evidence which consists primarily of outdated U.S. studies. The Commission will expect the company to file more detailed and more directly relevant evidence. In addition, the Commission will expect the company to discuss the treatment of the tax benefits which are associated with flotation costs incurred and which accrue to BCE.

4) Other Concerns

In final argument, CAC pointed out that some of Dr. Morin's estimates were based on U.S. companies. CAC argued that these estimates were irrelevant to the determination of Bell's cost of capital because of major differences between Canada and the U.S. in the structure of capital markets and in taxation. In their written evidence, Drs. Booth and Berkowitz also addressed the differences in financial and business risk encountered in Canadian as opposed to American markets. The company did not explicitly address this concern in its argument.

The Commission agrees with CAC and NAPO that there are major differences between Canada and the U.S. in the structure of capital markets and in taxation. In making estimates of the cost of common equity based on U.S. companies, adjustments must be made to reflect these differences. Since Dr. Morin made no such adjustments, the Commission has not considered the estimates based on U.S. companies in arriving at an ROE range.

During examination by Commission counsel, Dr. Morin agreed that the quarterly discounting model he employed is rarely used in Canadian regulatory proceedings. Commission counsel suggested to Dr. Morin that, since the annual discounting model is often used in Canadian regulatory proceedings, investors would naturally take this regulatory practice into account by bidding down the utility's stock prices (resulting in a higher expected return). Dr. Morin agreed that this description of investor behaviour is reasonable.

CAC argued that Dr. Morin's quarterly discounting model was seriously flawed because he failed to consider the fact that the rate of return would be applied to an average annual rate base. CAC urged the Commission to reject Dr. Morin's quarterly discounting model. Furthermore, CAC pointed out that none of the other expert witnesses had used the quarterly discounting model in their DCF estimates.

In its reply argument, Bell asserted that investors take into account the fact that the rate of return is applied to an average rate base. The rate base used is therefore reflected in the price of the stock and in the growth levels anticipated by investors.

In the Commission's view, the additional 30 basis points resulting from the application of Dr. Morin's quarterly discounting model have already been reflected in the dividend yield component of his DCF calculations. Therefore, the Commission considers that use of the quarterly discounting model overestimates the cost of common equity for Bell.

In reply argument, Bell stated that NAPO had not addressed the criticism of Dr. Booth's DCF study made by the Commission in Decision 86-17. According to Bell, Dr. Booth had not yet solved the problems associated with making reliable adjustments for inflation.

The Commission agrees with the company that Dr. Booth did not specifically address the Commission's criticisms of the DCF method that he presented in the proceeding leading to Decision 86-17. In the Commission's view, the comments that it made in Decision 86-17 concerning Dr. Booth's DCF methodology remain valid.

C. Conclusions

The Commission has examined the interveners' comments on Bell's capital structure. The Commission recognizes that, in certain situations, a higher debt ratio could result in a lower overall cost of capital to the company. However, the Commission notes in this regard that, generally, the evidence presented by the interveners did not thoroughly examine all of the factors relevant to the determination of an appropriate capital structure for Bell; nor did the interveners' evidence adequately address the long term implications of their respective proposed capital structures. For example, some of the interveners did not consider the extent to which the costs associated with a higher proportion of debt in Bell's capital structure would offset the stated benefits. The Commission notes that increases in debt financing costs associated with a higher debt ratio can arise from: (i) the higher interest rates of debt instruments of lower credit rating, as well as reduced flexibility in the size and frequency of debt issues; and (ii) the more onerous terms and conditions attached to debt financing of lower quality. In addition, a higher debt ratio increases financial risk, resulting in increases in the cost of common equity.

The Commission also notes that the lowering of corporate tax rates will reduce, to some extent, the after-tax benefit of the cost of debt in relation to the cost of common equity.

The Commission considers that the capital structure estimated by Bell in the JMP is reasonable and appropriate for maintaining the company's current credit quality in 1988. As the Commission has stated in Decision 86-17, it is mindful of the company's consistently large external financing requirements and the need to maintain and support its credit quality. The Commission has considered this question in prescribing the ROE range. However, the Commission would be concerned if, under current conditions, Bell were to strive to achieve a more conservative capital structure than that envisaged in its JMP.

In arriving at an appropriate ROE for Bell for 1988, the Commission has carefully weighed the evidence presented. While the Commission has relied on the three different methods for assessing a cost of common equity presented in this proceeding, it has found the specific analyses presented by the witnesses to be of varying degrees of assistance. The Commission has also taken into account developments in capital market conditions subsequent to the hearing, and the financial ratios necessary to support Bell's credit quality.

In light of all of these considerations, the Commission has determined that the ROE range approved for Bell for 1987 in Decision 86-17 continues to be reasonable for 1988. Accordingly, the Commission hereby approves an allowed rate of return on common equity of between 12.25% and 13.25% for the 1988 test year. The Commission considers this range to be fair to both subscribers and shareholders.

The Commission has used the middle point of the range, that is, 12.75%, for the purpose of determining the company's revenue requirement for the test year. The company is thereby provided with the means to enhance its return to shareholders through additional gains in efficiency. The ROE range will provide the company the flexibility to achieve the financial ratios in 1988 that, according to its evidence, it considers necessary for the support of its double-A credit rating.

VIII REVENUE REQUIREMENT

A. 1987 Revenue Requirement

In its letter of 23 June 1987, in which the Commission ordered the 1 July 1987 interim rate decreases for Bell, the Commission stated that it would issue a final order in respect of these interim rates. In 1987, the company earned an annualized ROE on a regulated basis of about 12.9% for the second half of 1987 and 13.2% for the whole year. Since the company has earned an annualized ROE for the second half of 1987 that falls within the prescribed ROE range of 12.25% to 13.25% set in Decision 86-17 for the 1987 test year, the Commission concludes that the interim rates were just and reasonable for the period in question.

B. 1988 Revenue Requirement

Taking into account the adjustments set out in the foregoing sections in respect of operating revenues and expenses, and the conclusions on accounting for real estate set out in Decision 88-3, the Commission estimates the operating revenues, assuming that interim rates are in effect for the whole of 1988, to be some $6,560 million in 1988 and the operating expenses to be some $4,840 million in 1988. Including further adjustments for the compensation for temporarily transferred employees, and a deemed 14.75% after-tax return on Bell's average investments in non-integral subsidiary and associated companies, the Commission determines that a revenue requirement reduction of about $40 million will provide the company with a 12.75% ROE on a regulated basis in 1988. In relation to the company's JMP forecast, which assumes that the interim rate reductions are withdrawn effective 1 April 1988, this represents a revenue requirement reduction of some $90 million in 1988.

C. Distribution of 1988 Excess Revenues

Bell indicated that, in the event the Commission determined that there would be excess revenues in 1988, the company would prefer that these revenues be used to reduce the company's non-intra toll rates below the levels proposed in Tariff Notice 2270A. The company indicated that, in the immediate future, it would prefer to place more emphasis on its non-intra toll rates than on its intra toll rates. Bell submitted that TransCanada MTS rates are further out of line with costs than are rates for intra MTS.

Ontario and CAC were of the view that any excess revenues should be applied on an equal percentage basis to all of the company's monopoly services. CAC submitted that all users of the network should share equitably in rate reductions due to excess revenues. CAC further submitted that, if excess revenues were applied only to long distance rates, the benefits would flow primarily to large long distance users of the network.

Québec was of the view that excess revenues should be used to reduce, if not completely eliminate, the impact on local service rates of the toll rate reductions requested in Tariff Notice 2270A.

Consistent with the approach taken in Decision 86-17, the Commission is of the view that excess revenues at existing local and interim toll rates should be used to reduce toll rates. In that decision, the Commission stated:

In Interexchange Competition and Related Issues, Telecom Decision CRTC 85-19, 29 August 1985 (Decision 85-19) the Commission concluded that significant social and economic benefits would result from the reduction of rates for message toll service (MTS) and wide area telephone service (WATS). However, in the context of Decision 85-19, these benefits had to be balanced against the impacts of local rate increases that would necessarily result from MTS/WATS rate reductions, in order to meet the same overall revenue requirement.

The circumstances of the current proceeding differ in that, due to the existence of an excess of revenue, the Commission has the opportunity to afford Bell subscribers the benefits of reduced MTS/WATS rates without imposing any rate increase on subscribers to local service. The Commission has decided to use this opportunity to afford these benefits to the company's subscribers by reducing MTS/WATS rates.

IX RATE REBALANCING

A. Background

In Decision 85-19, the Commission determined that full rate rebalancing, as exemplified by Bell's and B.C. Tel's illustrative rate rebalancing proposals, was neither necessary nor desirable at that time. The Commission noted that, while toll calling would be significantly expanded, the cost of telephone service for the majority of subscribers would be increased. Moreover, without the development of a subsidy program, basic telephone service could become unaffordable to some subscribers.

The Commission was convinced, however, that a number of economic and societal benefits would flow from a reduction in MTS/WATS rates. In this regard, the Commission stated the following:

A lowering of MTS/WATS rates is necessary at this time to reduce the communications costs experienced by Canadian businesses. In addition, a reduction of such rates will lessen the potential for future diversion of traffic, from Canadian telecommunications carrier networks, within Canada and through the U.S. and will reduce the incentive to divert investment and jobs to areas outside Canada where there is a lesser discrepancy between the costs and rates for MTS/WATS service. A lowering of MTS/WATS rates will thereby strengthen Canada's economy and its ability to play a leading role in the emerging global information economy.

In the Commission's view, a lowering of MTS/WATS rates would serve an important social purpose in addition to providing economic benefits. In particular, it would serve to increase national communications and understanding by facilitating communication between people, both within and among the various regions of Canada, and especially for those residing in sparsely settled and remote regions of the country.

Finally, a lowering of MTS/WATS rates would reduce incentives for uneconomic entry and create an environment better suited for competitive entry in the MTS/WATS market should that, in the future, appear desirable.

The Commission further stated that a number of rate rebalancing related issues remained to be determined, including the appropriate amount of MTS/WATS rate reductions, the method for achieving those reductions, the time period over which they should be achieved and the methods to ensure the maintenance of universally affordable service. Moreover, the Commission indicated its willingness to participate in a consultative process with federal and provincial representatives on these issues. In that regard, the Commission together with provincial government and regulatory representatives prepared a report, released in October 1986, entitled Federal-Provincial Examination of Telecommunications Pricing and the Universal Availability of Affordable Telephone Service (Federal-Provincial Study).

In Decision 85-19, the Commission stated that these outstanding issues regarding rate rebalancing had to be resolved as quickly as possible. In order that the situation with respect to the level of MTS/WATS rates did not worsen, the Commission stated its intention to freeze the aggregate level of MTS/WATS rates, thus permitting real rates to fall at the rate of inflation. The Commission noted that it was of the view that further MTS/WATS rate reductions would be required.

In Decision 86-17, the Commission subsequently reduced Bell's intra MTS rates by 20%, effective 1 January 1987.

Under Tariff Notice 2270A, Bell proposed across the board rate increases of $1.25 for all primary exchange services other than two-party and four-party residence services, for which an increase of $.80 was proposed. Under this rebalancing proposal, the revenues generated by the local rate increases would be used to implement compensating monopoly toll rate revisions. During the proceeding, the company proposed an additional four or five phases of rebalancing involving similar local rate increases and corresponding toll rate decreases.

The following sections deal with issues raised in this proceeding in relation to Bell's rebalancing plan.

B. Costing

Bell's evidence in this proceeding, based on projections from 1984 Five-Way Split estimates, indicated that, if local rates were not increased, the local/access category shortfall would increase from $1.4 billion in 1984 to $2.4 billion in 1986. Moreover, Bell contended that the access category shortfall was expected to grow at a rate of $180 million per year during the period 1988-1991. Bell noted that, even with annual local rate increases of $1.25, its proposal would only decelerate, not eliminate, the growing shortfall.

Bell noted that its Five-Way Split projections were comparable to its Phase III study results. The Phase III results demonstrate an access shortfall of $2.2 billion, a local surplus of $0.5 billion and a toll surplus of $1.8 billion. Bell noted that this growing shortfall stems from an increase in the base of total NAS, the current costs of which are greater than embedded costs due to inflation and longer loops. The company also noted that contribution on the toll side could be expected to increase since, as a result of new technologies, current costs are lower than embedded costs.

A number of parties, including BCOAPO et al, 'et', Québec and NAPO, questioned the basis for Bell's costing results. NAPO noted that the Commission had rejected the Five-Way Split in Inquiry Into Telecommunications Carriers' Costing and Accounting Procedures: Phase III - Costing of Existing Services, Telecom Decision CRTC 85-10, 25 June 1985 (Decision 85-10) and that the Phase III results were only tentative.

While the Commission has yet to rule on the acceptability for regulatory purposes of the Phase III manuals and associated results for 1986 filed by Bell on 30 September 1987, the Commission notes that these results are similar in magnitude to the Five-Way Split projections. The Commission is satisfied that the costing information provided by Bell provides a reliable indication that the access category shortfall is growing and that, while both monopoly local and toll services contribute to the recovery of access costs, the surplus of toll revenues over costs continues to be the major contributor towards the recovery of access costs. Moreover, due to continued growth in the provision of NAS, the Commission notes that the amount of contribution required from toll service is increasing.

C. Access Cost Recovery

According to Bell, based on its Phase III results, about 30% of the access category shortfall is recovered from a revenue surplus in the Monopoly Local category and the remaining 70% from the Monopoly Toll category. The company argued that it is economically inefficient to recover such non-traffic sensitive costs through non-causally related usage rates.

However, Bell did not propose a separate charge for access, but rather, through the rebalancing process, proposed to shift a portion of access cost recovery from monopoly toll services to monopoly local services.

Some interveners, particularly BCOAPO et al, B.C., STCC and NAPO, argued that some access costs were traffic sensitive, and could be causally related to network services. Moreover, these interveners contended that increased access costs were related to a variety of factors, such as increased access arrangements for various service providers, specialized and peak requirements of business users, and higher quality requirements of toll and data services. Accordingly, they argued it would be improper to recover all the costs of access through local service rates.

Ontario and the Director were among the interveners that argued against the bundling of access and local service. The Director submitted that tariffs which give subscribers options, including measured and flat-rate options, provide the most efficient long term solution to the pricing of access and local usage. The Director recommended that, as a first step towards this type of pricing, the Commission unbundle local rates into two flat-rate components, one for each of access and local usage, and direct further follow-up studies and analyses of local measured service (LMS) by Bell and independent experts.

Dr. Stanbury, on behalf of CNCP, considered that Bell's proposed method of allocation was arbitrary and failed to recognize a variety of ways in which access costs may be recovered.

CBTA et al stated that, on efficiency grounds, the preferred method of joint cost allocation is the inverse elasticity rule, and that current application is consistent with this approach. In its argument, however, CBTA et al submitted that access costs are not joint costs and that the question of allocation does not arise. CBTA et al noted that all consumers purchase access to the system and obtain benefits from access whether or not they make local or long distance calls. Finally, CBTA et al argued that the Commission had already determined that access costs are not usage sensitive and should be recovered on a flat-rate basis.

As noted, the Director also considered that access costs should be recovered on a flat-rate basis. However, the Director also noted that there may be sufficient complimentarities and externalities related to access to justify pricing it lower than cost. The Director also contended that costs in the Phase III access category, such as network private loops, should not be included in determining costs to be used in establishing rates for subscriber access.

NAPO argued that it is more likely that subsidies actually flow from residence to business users due to the fact that the network is designed to meet the usage requirement of business during peak periods. NAPO argued that use of the network by residential subscribers imposes only marginal costs on the network. Also, NAPO alleged that Bell has a considerable oversupply of excess capacity in local loops which is causing access costs to be too high. It argued that it is inappropriate to suggest that the considerable cost of excess capacity in loop plant should be allocated to individual subscribers. Based on its assessment, NAPO argued that the access shortfall disappears when the cost of the oversupply of excess capacity is excluded and a 50/50 allocation between toll and local is used.

The Director and Bell both argued that the true cost per loop has to be based on the amount of loops in service (and thus capable of producing revenues) rather than the total number of loops in place. CBTA et al also argued that NAPO's evidence is flawed since it does not provide any allocation for spare capacity. Moreover, CBTA et al argued that a 50% allocation of access costs to local would support the direction of Bell's application.

In regard to the arguments of interveners that access costs are causally related to each of the services that make use of access facilities, Bell noted that the Commission has previously determined that access costs are not traffic sensitive.

In regard to the Director's support for the introduction of LMS, the company asserted that, based on both economic and customer acceptance considerations, it did not consider LMS to be warranted at this time. Bell was of the view that, as long as there is no introduction of usage sensitive pricing into the local network, the unbundling of local rates into flat-rate components would be a simple bookkeeping exercise and of no substance.

Bell noted that elements within the access category are in accordance with Phase III guidelines. Moreover, it noted that elements such as loops for private networks contribute some $250 million in revenues to the access category. In Bell's opinion, its rebalancing plan only moves in the direction of recovering access costs on a cost causation basis. It contended that price would still be so far below marginal cost that specific arguments with respect to externalities and other matters have no immediate relevance.

With regard to spare capacity, Bell noted that its capacity requirements are reviewed annually in the CPR and have been found adequate. Bell argued that it is appropriate to include the costs of spare capacity in determining the costs of access, since building spare capacity into the system results in less costly service.

Bell disputed the allegation that toll or data requirements affect the design and cost of the local loop. It did note that it was often the case, however, that a byproduct of maintaining transmission quality for local service was suitable transmission for long distance calling. The company added that there was little that could be done to change the nature of the basic copper loop.

The Commission continues to take the view expressed in Decision 85-19 that access costs are not usage sensitive and are caused by subscribers obtaining access to network facilities. The Commission also agrees with parties who argue that local service does not cause access costs to be incurred. However, the Commission is of the view that the mere separation of existing local rates into flat-rate components for access and usage would serve little purpose. Such an unbundling would not alter the prices or incentives facing subscribers, provide them with any more flexibility than they currently have, or have the effect of making rates more closely reflect the usage sensitivity of costs.

The Commission also notes that, unlike the basic subscriber access line, other components in the access category do generate revenues towards the recovery of access costs. In the Commission's view, the removal of these revenues and costs from the category for rate setting would not significantly affect the level of access cost shortfall per basic subscriber NAS.

In the context of its Phase III considerations, the Commission intends to explore the feasibility of producing a breakdown of the embedded costs within the access category.

With regard to spare capacity, the Commission considers that it is reasonable to build spare capacity into the system in order to ensure that access can be provided in a timely and cost-effective manner. Accordingly, the Commission considers it appropriate to include a certain amount of spare capacity in estimating the costs of access. In this regard, the Commission notes that Bell's capacity utilization is reviewed annually in the CPR.

D. Universal Service

Bell stated that local telephone service has become affordable for virtually all households in its territory. In support of this position, the company noted that the penetration rate over the past several years has been consistently in the 98% to 99% range. Moreover, Bell cited findings of the Federal-Provincial Study that indicate that local telephone service consumes approximately one-half of one percent of disposable income for the average household in major urban areas. Further, the company contended that, taking inflation into account, local service would be as affordable as it was in 1983 if Tariff Notice 2270A were approved.

Bell did not consider that the objective of maintaining universal service was threatened either by Tariff Notice 2270A or by its further rebalancing plan. It noted that if, in the future, universality were ever threatened, it would be prepared to participate in the development of a suitable method of preserving accessibility. While the company stated that its preferred approach would be a targetted subsidy program funded through the tax base, it noted that it would be prepared to administer such a program through an incremental charge to the basic local rate.

Bell provided estimates of residence NAS curtailment that suggest that penetration NAS could be about 10,000 lower than otherwise if Tariff Notice 2270A were approved. Bell noted that the majority of the 10,000, some 7,000, represents households that, given higher monthly and non-recurring rates and other factors, would decide to delay re-connecting to the network after moving. It anticipated that an additional 2,000 households currently without service would decide to delay joining the network. The company projected that approximately 1,000 of the 10,000 households would represent subscribers disconnecting as a result of the proposed rate changes.

In support of its conclusions that approval of Tariff Notice 2270A would cause minimal impact on penetration, the company cited evidence indicating that, while local rates increased some 40% in the United States from 1983, the penetration rate actually increased as well. Bell argued that the elasticity of demand for local service is less sensitive in Canada than in the United States, indicating that there is less chance of drop-off in response to a price increase in Canada.

The company also argued that a key factor in subscribers dropping off the network is the high cost of long distance service. Finally, the company noted that only 30% of subscribers dropping off the network were aware of lower-priced two-party and four-party services. Bell contended that subscribers contemplating disconnection due to price increases could, by moving to two-party service, obtain service at rates lower than they were paying prior to any increase.

In its argument, STCC contended that stable penetration rates can hide the existence of drop-off in terms of actual households disconnecting. Québec noted that it is concerned whenever any subscribers are forced to discontinue service. CAC noted that, while penetration rates would be unlikely to change due to the present application, such rates could actually rise in the absence of rebalancing. CAC contended that rising income and low inflation tend to swamp the effect of rising prices. Moreover, CAC and other interveners expressed concern about both drop-off and universality were Bell to increase rates each year cover the next five years. CAC noted that as many as 32,600 households, or 100,000 persons, could be without service as a result of the 5 year rebalancing plan.

Interveners such as BCOAPO et al, CAC and NAPO submitted that, while most subscribers would remain on the network if Tariff Notice 2270A were approved, the price increase would force low income subscribers to reduce spending on other essential items such as food and clothing.

CAC and BCOAPO et al noted that reconnection and installation charges are also factors that contribute to drop-off. BCOAPO et al and NAPO also argued that, assuming targetted subsidies were not contrary to the Railway Act, they are nonetheless demeaning to subscribers and thus ineffective.

In the context of rate rebalancing in Decision 85-19, the Commission stated:

In the Commission's view, the universal accessibility of service is, and will remain, of fundamental importance both to protect subscribers and to maintain the value of the telephone network. In consequence, it is important to consider the extent to which rebalancing could be in conflict with this principle.

In the opinion of the Commission, this position remains equally valid in the context of this proceeding.

Based on the record of this proceeding, the Commission is of the view that local rate increases of the magnitude proposed under Tariff Notice 2270A would be unlikely to have significant impact on universality. Nevertheless, the Commission considers that the issue of subscriber drop-off is of such importance that mechanisms to monitor drop-off are essential in the public interest.

E. General Economic Impact of Rate Rebalancing

In support of Tariff Notice 2270A, Bell provided two macro-economic studies, prepared by Informetrica Ltd. and Wharton Econometrics (Wharton), that indicated that there were net benefits associated with its proposal. Bell noted that these studies forecast $223 million and $150 million, respectively, in annual macro-economic benefits. Both studies forecast that, if such rebalancing were carried out, inflation would decrease, government balances would improve and employment would increase. The company noted that a study by Wharton in 1986 on the impact of subscriber line charges showed positive macro-economic benefits as a result of rate rebalancing in the U.S.

The company submitted that, in terms of distributional impacts, all households would benefit, since households in all income classes make toll calls. In addition, Bell contended that low income households could benefit from increased employment or increased transfer payments if increased government balances were so deployed.

Bell also provided its own consumer surplus study on its present application. The analysis conducted indicated a net benefit in consumer surplus of $30 million. In the context of the distribution of benefits, Bell contended that all gains ultimately flow through to residential subscribers, either directly or in reduced consumer prices for other goods and services.

In regard to both macro-economic and consumer surplus studies, Bell noted that gains to consumers from lower business costs arise from a variety of factors, including lower prices, higher wages and benefits, higher dividends and increased capital expenditures resulting in increased employment.

In respect of these studies, NAPO argued that the alleged benefits resulting from rebalancing are too small and that, in practice, the impact of rebalancing on the economy could therefore never be isolated. NAPO, CAC, Ontario and B.C. also contended that the distribution of the benefits would be inequitable, particularly for low income subscribers.

STCC noted that a 1986 D.A. Ford/Informetrica study (D.A. Ford study) had assessed the macro-economic benefits of a lowering of business telecommunications rates, but had neglected to include corresponding cost increases for other classes of users. This, STCC contended, should lead the Commission to approach econometric models with caution.

BCOAPO et al and CAC noted that many of the underlying assumptions in the macro-economic studies had been provided by Bell and that alterations to these assumptions would change the results.

In its argument, CAC contended that benefits were overstated because the studies assumed that business would pass all its savings through to consumers in the form of lower prices. CAC argued that, if only 50% of such savings were passed through to consumers, then the positive impact on Gross National Product would disappear. Moreover, CAC noted that Bell's assumption limiting employment gains in the telecommunications industry had the effect of restraining the inflationary factor in the model, thus allowing the model to predict larger benefits.

In reply, Bell stated that, while the macro impacts may not appear large, they are significant in absolute terms. Moreover, Bell contended that larger benefits could not be expected from a modest rebalancing plan.

While Bell submitted that business savings are passed through to households in a variety of ways, it did agree that inflation would not fall if these savings were not passed through in lower prices. However, Bell noted that, in that case, wages and nominal income would not fall either. In regard to its productivity assumptions, Bell noted that its productivity has always been higher than that experienced by the economy as a whole.

In Decision 85-19, the Commission concluded that, based on the record of the proceeding, rate rebalancing could yield important economic benefits. While the Commission noted that studies were not extensively canvassed in that proceeding, it did consider that they were indicative of the general economic gains to be derived from rebalancing. Having weighed the arguments concerning the Informetrica and Wharton studies and the consumer surplus and other macro-economic studies, the Commission considers that these studies support claims that generalized economic benefits would result from rebalancing. While the Commission recognizes that the benefits of rate rebalancing would not necessarily be distributed evenly, it considers that, to the extent that the economy gains as a whole, consumers will generally be better off.

F. Impact on Various Classes of Subscribers

Bell argued that long distance service can no longer be considered a luxury since, in all demographic groups, more is spent on average for long distance than for basic local service. The company noted that 14% of households in the below $10,000 per annum income group would save money if Tariff Notice 2270A were approved. The company contended that the status quo could not be considered equitable since it requires long distance users, including low income subscribers, to pay a price considerably in excess of costs in order to substantially subsidize local subscribers, including high income users and subscribers with second lines to cottages and teenagers' bedrooms.

The company argued that lower MTS/WATS rates would reduce the costs experienced by Canadian businesses and strengthen Canada's economy and ability to play a leading role in the global information economy. The company argued that the industries that use telecommunications extensively are the information intensive industries which represent the fastest growing sectors of the economy.

The company further argued that lower MTS/WATS rates would serve an important social purpose by facilitating communications in sparsely populated or remote areas of the country. Moreover, the company estimated that its application would result in an additional 9 million residence long distance calls being placed, including 1.5 million calls by low income subscribers.

Interveners such as CAC, FNACQ, ACEF, NAPO and TWU contended that Bell's rebalancing plan amounted to a transfer of wealth from consumers and small business in favour of large corporations and, as such, was both inequitable and unnecessary. In support of this position, these parties noted that 80% of residence and 60% of business customers would have higher total bills as a result of rate rebalancing. B.C. argued that, since the benefits for large business would be at the expense of consumers, particularly those consumers in low income brackets, the overall benefits to society would be outweighed by the disadvantages. NAPO argued that it is important to focus on the impact of the application on classes of subscribers, and not on services, since services are consumed by "real" people.

CAC noted that only subscribers in the plus $50,000 per annum income bracket would make, on average, more than the $26 of monthly toll calls necessary to break even at the rates proposed under Tariff Notice 2270A. Moreover, CAC noted that a higher percentage of users in the lowest income bracket make no toll calls. CAC also noted that, with flat rate increases to local service, customers in rural and remote areas would face proportionately higher increases. Moreover, CAC noted that such subscribers would receive smaller toll rate decreases, since much toll calling in rural areas is to the closest community, while Bell's proposed MTS rate decreases only take effect beyond the 40 mile band.

Both Ontario and ACEF noted that Commission policy in past rate decisions had been to keep residential rates as low as possible by loading the greater proportion of rate increases on business users. Ontario urged the Commission to remain aware of social policy considerations.

With respect to business costs, CAC noted that, since the Commission's determination in 1985 that there would be benefits from a lowering of MTS/WATS rates, business has already received significant reductions. CAC argued that telecommunications costs account for less than 1% of total costs for most businesses, and only 2 to 5% of total costs for more information intensive businesses. In this regard, NAPO noted that savings in telecommunications costs as a percentage of operating expenses would be unlikely to have any impact on prices paid by consumers.

CAC also noted the findings of the D.A. Ford study that lower telecommunications costs were not considered a major factor in international competition or in locating a business. Moreover, CAC argued that any competitive advantages to U.S. businesses from lower U.S. rates could be reduced if price cap regulation were implemented for American Telephone and Telegraph Company (AT&T), as is presently contemplated by the U.S. Federal Communications Commission. Finally, CAC noted that 60% of businesses would face bill increases if Tariff Notice 2270A were approved.

In its argument, CBTA et al noted that the Commission has, in the past, approved toll rate increases that were higher than local rate increases, taking into account the perceived policy objectives of the time. CBTA et al argued that, in the context of current policy, rate rebalancing is a response to existing market and technological conditions. CBTA et al contended that the gap between Canadian and U.S. toll rates is widening due to continuing reductions in U.S. rates and the imposition by the Canadian government of the 10% telecommunications sales tax.

CBTA et al submitted that the present system of untargetted subsidy is a clumsy and expensive approach to addressing distributional and equity concerns. CBTA et al, the Director and Dr. Stanbury favoured pricing services more efficiently and making equity concerns more explicit via targetted subsidies.

With regard to arguments that only 20% of residence and 40% of business subscribers would benefit from approval of Tariff Notice 2270A, Bell contended that the macro-economic evidence indicated that the average subscriber would actually benefit in the amount of $0.65 per month. Further, Bell submitted that residential telephone usage consumes, on average, only one-half of one percent of disposable income for the average household in urban centres. Finally, Bell noted that the average bill increase would amount to 1.2%, a real price decline in inflation-adjusted terms. Bell noted that the average monthly business bill would decline by $11.60 as a result of its application, and that the average increase of $1.51 for businesses facing an increase amounted to a 4% price decline in inflation-adjusted terms.

With regard to rural and remote area subscribers, the company noted that the smallest bill increases, and even bill decreases, would occur in the rate groups that most of these subscribers were in.

Bell also noted that calls in all mileage bands were captured by the proposed Saturday morning discount. Further, Bell noted that the majority of calls in many northern and remote areas are of distances greater than 40 miles. In regard to rates for businesses, both Bell and CBTA et al argued that parties that lump all business together hide the significant benefits that would accrue to economically important industries, as opposed to the minimal impacts on the majority of small businesses such as the barber shop or corner store.

With regard to its policy of keeping local rates low, the Commission agrees with CBTA et al that its regulatory objectives must take account of changing conditions. In this regard, the Commission notes that, even during periods of high inflation when local rates were kept as low as possible, it attempted to find the additional revenues needed to meet revenue requirements from sources other than rates proposed for monopoly toll service. The Commission also kept residence local rates low by increasing rates for competitive services beyond the then existing or even proposed levels. In Bell Canada - General Increase In Rates, Telecom Decision CRTC 81-15, 28 September 1981, the Commission reduced proposed MTS rate increases, recognizing that this service was also a monopoly service.

The Commission is concerned that heavy users of MTS/WATS monopoly services are being required to contribute increasingly greater amounts towards the recovery of access costs at the very time the costs of providing MTS/WATS are declining.

While the Commission notes that, under Tariff Notice 2270A, subscribers without Extended Area Service (EAS) or other discounts would not receive toll reductions for calls under 40 miles except on Saturdays, it does not agree that rural and remote subscribers would be made proportionately worse off than other subscribers. The Commission notes that rural and remote subscribers are in rate groups that would face, on average, lower total bill increases. Moreover, in northern communities, the majority of calls are of distances greater than 40 miles and are currently subject to toll discounts.

As noted by the Commission in Decision 85-19, rate rebalancing would result in bill increases for the majority of subscribers. At the same time, as was also noted in that decision, the minority of subscribers, those who are heavy toll users, are currently paying bills in excess of the costs of serving them, while the majority are paying bills below these costs. As a result, heavy toll users are required to pay, on a per NAS basis, a disproportionately higher share of contribution towards the recovery of access costs. While Bell's rate rebalancing plan would lower the bills of heavy toll users, it should be noted that, even under its plan, the majority of subscribers would still be paying bills below costs and heavy toll users would still be required to make significant contributions towards the recovery of that shortfall.

Finally, the Commission considers that, while Tariff Notice 2270A entails small increases for 60% of business customers, it would entail significant benefits in the service sector. Given the growing importance of the information and service sectors, the Commission considers that rate rebalancing would ease the burden of access recovery on these industries and augment their ability to obtain cost effective communications.

G. Competition and Bypass

Bell argued that there has been increasing competitive pressure on its MTS/WATS revenues and contributions. In Bell's opinion, rate rebalancing would contribute to a more rational competitive environment and diminish the need for restrictions on entry.

In terms of MTS/WATS competition, Bell noted that rate rebalancing would prevent uneconomic entry and bring a competitor's contribution payments down to manageable levels. The company noted that, under present pricing, contribution would be a competitor's largest cost. Moreover, a competitor paying full contribution would require a 46% cost advantage in order to bring about a 15% price discount.

Bell argued that rate rebalancing should precede any competitive entry into the MTS/WATS market. The company considered that current levels of contribution could not be sustained if entry were permitted. Bell contended that, while there is a substantial contribution, entry would put pressure on the contribution mechanism and accelerate the pace of rebalancing.

While Bell contended that a rational competitive environment would still not exist even if its multi-year rate rebalancing plan were implemented, it indicated that full rebalancing would not be required prior to allowing further competitive entry into the MTS/WATS market.

In Bell's opinion, rate rebalancing is superior to competition as a mechanism for efficiently reducing toll rates because all revenues from local rate increases are applied to toll rate reductions.

The company noted that bypass was not substantial at this time. However, it argued that the artificially high cost of long distance, increasing demand for communications and pressures to reduce costs are increasing pressures to bypass. The company also noted that the availability of cheaper, U.S. based service is providing further incentives to bypass.

Interveners such as CAC, BCOAPO et al, NAPO and TWU contended that Bell was utilizing the threat of contribution erosion from competition and bypass as the main argument in support of rate rebalancing. They argued that rate rebalancing would permit Bell to shelter more revenues on the monopoly side and gain a competitive advantage at the same time. In that regard, NAPO noted that the shift of access payments from competitors to subscribers was resulting in AT&T becoming more dominant in the U.S. market.

CAC and BCOAPO et al, among others, argued that bypass was illusory and not inevitable. CAC noted that evidence in the U.S. indicates that the incidence of local bypass is minimal and driven more by quality considerations than by price.

CAC also noted that opportunity, as well as incentive, had to be present in order for bypass to occur. CAC noted that the Federal-Provincial Study had found such opportunities to be limited within Canada.

CAC also rejected Bell's proposition that competition was inevitable. CAC argued that the Commission has denied entry and can continue to deny entry; that, as a result of advances in fibre optics and digital switching, the market is displaying natural monopoly characteristics, and that AT&T is displaying market dominance while MCI Telecommunications Corporation (MCI) and U.S. Sprint Communications Company (U.S. Sprint) continue to struggle. CAC contended that, in the relatively smaller Canadian marketplace, MTS/WATS competition would prove even less viable than in the U.S.

The Director, CNCP and CBTA et al favoured competition as the optimum means of lowering price, while affording users the benefits associated with innovation, increased productivity and choice. CBTA et al noted that a number of competitive opportunities other than facilities based MTS/WATS competition had been introduced. These included resale and sharing and enhanced services. CBTA et al and CNCP contended that the existence of economies of scale and scope does not provide sufficient grounds for denying competition, since established suppliers may gain sufficient scale by expanding into new markets. Alternatively, new suppliers could focus on particular market niches. The Director argued that technological change had transformed the economics of telecommunications, permitting a number of contestable markets in place of natural monopoly.

CBTA et al argued that the possibility of increased competition and bypass was real, and that the incentives for both were increasing due in large part to the growing disparity between Canadian and U.S. rates.

CNCP noted that the per minute contribution from toll rates had already been reduced to $0.23, due to past toll reductions, and questioned what level of contribution would be appropriate for permitting entry. Interveners, including the Director and Ontario, contended that it was the responsibility of the Commission, not Bell, to determine the appropriate level of contribution.

In Decision 85-19, the Commission concluded that, in the immediate future, the occurrence of bypass would not be so extensive as to require full rate rebalancing. However, it found that, over the longer term, bypass opportunities both within Canada and through the United States would create pressures for a lowering of MTS/WATS rates. The Commission agrees with interveners in this proceeding, however, that bypass does not seem to be extensive at this time.

In regard to evidence from CAC concerning local facilities bypass, the Commission notes that telephone companies are providing their own dedicated connections in order to counter bypass. While these measures retain traffic, they result in reduced contribution.

Finally, the Commission notes that, while the Federal-Provincial Study found that opportunities for bypass are limited, the study also found that the present barriers to bypass are fragile and could be eroded by factors such as changes in exchange rates, liberalization of microwave licensing policy, the interconnection of satellite earth stations, and customer control of PBXs. In the opinion of the Commission, disparities in Canadian and U.S. rates, awareness of cross-border services and increasing diffusion of technologies will all increase incentives and opportunities to divert revenues from Canadian MTS/WATS services if such services are priced too high.

With regard to the issue of MTS/WATS competition, the Commission notes that, provided universality of service is not compromised, rate rebalancing would facilitate the creation of a more rational environment by reducing contribution payments and would permit competition based on prices bearing a closer relationship to the actual costs of providing service.

H. Future Rebalancing Applications

NAPO, TWU, CAC, CNCP, BCOAPO et al, 'et' and the Director were among the interveners that criticized the lack of detail in Bell's rate rebalancing plan. BCOAPO et al, among others, contended that approval of the plan would make rate rebalancing irreversible. In the opinion of the Director, Bell has not provided the type of information contemplated by the Commission in Decision 85-19, such as the amount of the reduction, the time period of the reduction and mechanisms to ensure universal availability. The Director argued that the Commission must determine the agenda, since rate rebalancing will have a profound impact on the evolution of the industry.

It was Bell's position that, three or four years into the implementation of its plan, it would be necessary to assess the impact it was having on subscribers, prevailing market conditions and competitive pressures. The company noted that competition could force the acceleration of the plan; however, full rate rebalancing would not be required prior to the entry of competition.

CBTA et al argued that Bell had a plan and, if implementation of the plan was required in order to allow for competition, then it should proceed.

As evidenced by its specific observations in the foregoing sections, the Commission considers that the record of this proceeding firmly supports the principle of rate rebalancing. While the Commission agrees that the establishment of a definitive plan for rebalancing would be desirable, it does not consider the development of a detailed and firm long term plan to be feasible. In the first place, the degree of rate rebalancing necessary to foster an environment of effective competition depends on the type of entry to be permitted. Neither the timing nor the nature of such entry can be determined here. Moreover, the extent of rebalancing which may be appropriate can vary depending on the level and growth of the access shortfall and the disparity between Canadian and U.S. rates. The level of inflation in any year and particular revenue requirements can also influence the level of both toll and local rates. Finally, the appropriate extent of rate rebalancing would be tempered by any impact occurring on penetration and subscriber drop-off.

In assessing the need for the specific rate changes proposed under Tariff Notice 2270A, the Commission finds that there are sufficient excess revenues at existing local and interim toll rates to enable it to approve the MTS rate reductions that Bell applied for without the need to increase local rates. The Commission recognizes that, under such circumstances, Bell's preferred solution would be to use the excess revenues in conjunction with the proposed local rate increases to reduce non-intra rates even further. The Commission considers, however, that such further reductions are not necessary in this proceeding given that all the MTS reductions that Bell considered necessary are being approved and that negotiations among the members of Telecom Canada are underway to further reduce non-intra rates. Accordingly, the Commission has concluded that an increase in local rates is not required in the context of this proceeding.

Finally, the Commission has concerns with regard to the mechanics of identifying drop-off and maintaining universality as a consequence of future rate rebalancing applications. Accordingly, Bell is directed to include, with any subsequent application to rebalance, a detailed report on the methods to be employed to monitor drop-off and penetration levels and to separate disconnect cases due to rebalancing from those ascribable to other causes. The report should address various alternative methodologies that could be employed to this end, and describe any existing data or studies that could be used in comparing subscriber behaviour and views, with and without rate rebalancing. Moreover, any such application should provide detailed evidence regarding its impact on drop-off and details of a company-administered targetted subsidy program to maintain universal access, including projected costs and methods of determining which individuals are qualified.

X REVENUE SETTLEMENT ISSUES

A. Removal of Single Member Traffic from the Telecom Canada Revenue Settlement Plan

1) Background

In Decision 81-13, the Commission concluded that the practice of including all revenues from Canada-U.S. and Canada-Overseas traffic in the Revenue Settlement Plan (RSP) was inequitable. This was considered especially true of traffic which engaged the facilities of only one member of Telecom Canada (single-member traffic). The Commission found the practice of including single-member traffic in the RSP to be particularly inequitable to Bell, in the case of Canada-U.S. traffic, and to Bell and B.C. Tel, in the case of Canada-Overseas traffic. The Commission therefore directed Bell and B.C. Tel to seek to renegotiate the RSP with the other members of Telecom Canada, with a view to excluding revenues generated by Canada-U.S. traffic and Canada-Overseas traffic that uses the facilities of only one member of Telecom Canada.

By letter dated 18 February 1982, Bell informed the Commission that Saskatchewan Telephones (SaskTel) had not been authorized by the Government of Saskatchewan to negotiate modifications to the RSP, pending intergovernmental agreement on the regulation of interprovincial telecommunications services.

At the time of Decision 81-13, the Commission estimated that the exclusion of revenues associated with single-member traffic from the RSP would result in approximately $52 million of additional revenue for Bell. By letter dated 4 September 1981, Bell indicated to the Commission that, using 1978 data, it had estimated the impact on Bell of removing single-member traffic to be a benefit of $13 million. Bell stated that the difference between the estimates was due primarily to the fact that the Commission had not taken into account the impact of excluding from the RSP the costs associated with single-member traffic and had included the impact of removing from the RSP revenues associated with transitted traffic which, under Decision 81-13 guidelines, would remain in the RSP. By letter dated 1 October 1982, Bell indicated that, using 1981 data, it had estimated the impact on the company of the removal of single-member traffic from the RSP to be a loss of $11.6 million.

In the response to interrogatory Bell(CRTC)20Mar87-710, Bell estimated that, in 1988, the impact of removing single-member traffic would be a benefit to Bell of approximately $6.5 million and a loss to B.C. Tel of $7.4 million. In addition, Bell estimated that Newfoundland Tel, Maritime Telephone and Telegraph, Island Tel, New Brunswick Tel and SaskTel would be worse off, but that Manitoba Telephone System and Alberta Government Telephones would be better off, if single-member traffic were removed.

2) Positions of Parties

Bell was of the view that the quantitative analysis noted above did not capture the adverse impact on all Telecom Canada members that would arise from the effect that the removal of single-member traffic would have on routing and settlement agreements with U.S. carriers and Teleglobe Canada (Teleglobe).

Bell stated that, under the current settlement arrangement, the routing of traffic is designed to achieve an efficiently engineered North American network, as opposed to being influenced by the individual member's settlement considerations. If single-member traffic were to be excluded from the RSP, Bell argued, individual members would route traffic in such a way as to maximize their individual settlements, rather than to maximize total Telecom Canada revenues, as is each member's incentive under the present system. In particular, Bell submitted that it would be in each member's interest to attempt to maximize the amount of Canada-U.S. traffic it delivers directly to U.S. carriers. The company stated that this would require altered routing arrangements, which would result in smaller and less efficient trunk groups.

During examination by Commission counsel, Mr. Walter, Vice-President, Marketing and Development, conceded that a new routing method, known as Dynamic Non-Hierarchical Routing, had diminished the company's concern over the extent to which efficiency might be reduced. Nevertheless, Bell maintained that, for members other than Bell, there would be decreased routing diversity because each member would provision facilities within its own territory with the objective of maximizing its individual revenue settlement. Bell was of the view that service quality might be endangered if members were to negotiate directly with U.S. carriers and treat their southbound traffic separately. According to Bell, service quality would suffer because some members might not find it feasible to maintain the existing level of routing diversity without using the facilities of other members.

Bell was also of the view that removal of single-member traffic would have an impact on Telecom Canada's agreements with U.S. carriers. Under the current agreements with each of AT&T, MCI and U.S. Sprint, a per minute accounting rate is applied to any imbalance in minutes of traffic. A payment is made by the carrier that delivers more traffic than it receives. Historically, there has been a northbound imbalance of traffic. Bell stated that, in 1986, this northbound imbalance resulted in a payment to Telecom Canada of about $30 million. According to Bell, the northbound imbalance has resulted in pressure from the U.S. carriers to lower the accounting rate and thereby reduce their settlement with Telecom Canada. Bell argued that, because of the incentive for each member to maximize its own settled revenues, it is unlikely that the same settlement agreement would be maintained with each U.S. carrier and each member company if single-member traffic were removed from the RSP.

Bell argued that, to the extent that individual Telecom Canada members have a southbound excess, they would press for a lower settlement rate in order to lower their individual settlement obligation. Bell stated that a break in the Canadian position of maintaining average settlement rates for all Canadian traffic could lead to a premature lowering of settlement levels, to the detriment of Telecom Canada members and their subscribers. Bell submitted that a scenario in which each member had separate agreements with each of the U.S. carriers could result. In addition, Bell submitted that the incentive for each member to deliver as much traffic as possible directly to the U.S. carriers could result in additional border crossing points and therefore greater costs for the U.S. carriers. Bell was of the view that this would place further downward pressure on the settlement rates.

With respect to the settlement with Teleglobe, Bell was of the view that removal of single-member traffic would change the current average settlement rate to a number of different settlement rates which would vary according to the cost of hauling the call on the domestic network to the international gateway. Otherwise, stated Bell, members without international gateways in their territories would likely attempt to establish their own gateways, resulting in higher costs and possible separate settlement agreements between each member and Teleglobe.

Bell was of the view that the settlement arrangements resulting from the removal of single-member traffic from the RSP would be complex and costly to administer.

Bell further submitted that the benefits of the current arrangement that the removal of single-member traffic could endanger include a) mutually agreed-upon through rates for most traffic between Canada and the U.S., and b) the effective administration of border crossing policies which enable routing in Canada that is equitable and consistent with network efficiency.

Bell suggested that the members would likely want to renegotiate the RSP for the TransCanada, Canada-U.S. and Canada-Overseas traffic still subject to settlement under the plan, in order to offset any disadvantages resulting from the removal of single-member traffic.

Finally, Bell submitted that the adverse impacts discussed above would result either if there were a single Telecom Canada agreement with each of the U.S. carriers and Teleglobe, or if each member had its own agreement with each of the U.S. carriers and Teleglobe.

B.C. Tel was of the view that the benefits of the current arrangement outweigh any apparent monetary advantages which the Commission may have assumed in arriving at Decision 81-13. B.C. Tel shared Bell's view that the removal of single-member traffic would result in complex settlement arrangements that were costly to administer, and that a change in one part of the settlement procedure could result in a renegotiation of the entire arrangement.

3) Conclusions

The Commission considered three scenarios for the treatment of single-member Canada-U.S. and Canada-Overseas traffic.

The first was the existing settlement arrangement. The second removed single-member traffic from the RSP and established separate agreements between each Telecom Canada member and each of the U.S. carriers and Teleglobe. The third was an intermediate scenario in which single-member traffic was removed from the RSP, but no changes were made to the existing Telecom Canada agreements with U.S. carriers and Teleglobe.

The Commission agrees with Bell and B.C. Tel that the disadvantages of the second scenario would outweigh the additional settlement benefit that might flow to Bell with the removal of single-member traffic. However, the Commission considers that pressures from other members to renegotiate the accounting rate settlements or to establish separate agreements with U.S. carriers would not likely develop unless there were members with a southbound excess of traffic. In this regard, the Commission notes Bell's statement in response to interrogatory Bell(CRTC)11May87-1729 that budget data on the northbound flow of message minutes were not available on a member-specific basis.

The Commission considers that, under the arrangement considered in the third scenario, there would, at a minimum, be increased administrative costs for all members.

The Commission has therefore decided, given the relatively small estimated impacts on Bell and B.C. Tel of removal of single-member traffic and the fact that these estimates do not take into account a variety of potential costs, that no change in the current settlement arrangements concerning single-member Canada-U.S. and Canada-Overseas traffic is required.

B. Impact on Independent Telephone Companies

1) Background

Bell interconnects with 42 independent telephone companies in Ontario and Québec. Each such interconnection is governed by one of two types of traffic agreements: a) a Commission and Line-Haul agreement or b) a Commission and Prorate agreement. Changes in Bell's toll rates can affect the settled revenues accruing to the independent telephone companies pursuant to those agreements.

On page 66 of Decision 85-19, the Commission stated:

... the Commission notes that it is required by statute to regulate the rates of federally-regulated carriers and that this requires it to make determinations which can affect the revenues of telephone companies which it does not regulate. At the same time, the revenues of carriers regulated by the Commission are affected by the rates charged by carriers not regulated by it ... The Commission is of the view that an assessment of such impacts would form an essential part of the consideration of any program of rebalancing or MTS/WATS rate adjustment.

2) Positions of Parties

Bell submitted that the impacts of rate rebalancing on independent telephone companies must be carefully considered. The company noted that the extent and nature of the impacts arising out of its rate rebalancing plan would vary from company to company depending on a number of factors, including the type of traffic agreement and whether the independent was located in Ontario or Québec. Bell provided broad scale estimates of the impact of its proposed rate rebalancing on independent company settlements. These indicated that settled revenues for Commission and Line-Haul companies would decrease by $0.7 million in Ontario and would increase by $0.1 million in Québec. For Commission and Prorate companies, settled revenues were expected to decline by $1.3 million in Ontario and $2.3 million in Québec.

As the Québec independents are not required by the Régie des service publics (the Régie) to adopt Bell's toll rates, the revenues subject to settlement under the Québec traffic agreements are based on the lower of Bell's or the particular independent's toll rates. The party whose toll rates are higher keeps the difference between its originated revenue and the revenue that would result if its originated traffic were rated at the lower toll rates. This difference is referred to as the excédent. Bell stated that the overall increase for the Québec Commission and Line-Haul companies would result from increases in the excédent, which would be greater than decreases in commissions.

Bell further stated that, although the Ontario Commission and Line-Haul companies would sustain an estimated overall decrease in settled revenues of $0.7 million as a result of rate rebalancing, the toll billing to their customers would decrease by an estimated $1.6 million. Bell stated that even if the entire settlement loss were recovered from independent company customers, the net benefit to the customers would still be $0.9 million. Bell stated that this relationship between settled and billed revenue impacts is caused by the fact that the "A" commission retention rate for all Ontario Commission and Line-Haul companies is less than 100 percent. Finally, Bell stated that the recent decision of the Régie (R.S.P. 87-004-B), filed as Bell Exhibit 81, showed that there has been no impact on the local rates of the Québec independents from either the 1 January 1987 or the 1 July 1987 Bell toll rate reductions.

By letters dated 12 November 1987 to CITA and to each Commission and Prorate company, Bell announced that it was prepared to negotiate with the independents and change its agreements with them in order to ensure that no company's settled revenues were reduced by toll rate reductions implemented solely by the other company. In the letters, which were filed in this proceeding as Bell Exhibit 53, Bell expressed the view that, if both Bell and an independent company together increase or decrease the toll rates charged to their respective subscribers, settled revenues should correspondingly increase or decrease for both companies. However, where only one company decreases the toll rates charged to its subscribers, the other company should not be negatively affected by the change.

Bell noted that the implementation of its 12 November 1987 proposal would result in toll rates for the independents which differ from Bell's. The company stated that, although it sees benefit in uniform rates over the longer term, this proposal provides a means for independent telephone companies, in conjunction with their regulators, to choose the extent and timing of toll revenue impacts associated with toll rate reductions for their subscribers. Bell noted that different rates have been in effect for some time in Québec, but Ontario independents have tradition ally used the same toll rates as Bell. Bell further noted that the Ontario Telephone Service Commission (OTSC), in Order 4948, dated 15 January 1987, stated that the policy of maintaining the toll rates of Ontario independents at the same level as Bell's must be reconsidered in light of changing circumstances.

Bell was of the view that its proposal could be negotiated and implemented without undue delay or difficulty. Bell estimated that, if all independents in Ontario and Québec took advantage of its proposal, its share of settled revenues would be reduced by approximately $3 million over the period 1 April 1988 to 31 March 1989. Finally, Bell noted that, whether the independents decide to take advantage of Bell's proposal or not, the existing procedures regarding the excédent provide a measure of protection to the Québec Commission and Line-Haul companies if the toll rates charged to their subscribers are not changed.

CAC was of the view that evidence prepared on its behalf by Mr. D.A. Ford clearly demonstrated that Bell toll rate reductions negatively affect the revenues of the independent telephone companies in Ontario and Québec. CAC was of the view that increases in local rates would be necessary in order to make up this loss of revenues. CAC submitted that CRTC decisions should not be permitted to cause substantial rate increases for subscribers of telephone companies under provincial jurisdiction.

Based on 1985 "A" commission data, Mr. Ford estimated that the impact on a sample of eleven Ontario independents of Bell's 1987 toll rate reductions amounted to reductions in settled revenues, expressed in dollars per 1986 NAS per month, ranging from $1.32 to $3.19 for the 1 January 1987 reduction and from $0.34 to $0.69 for the 1 July 1987 reduction. Based on estimated "A" commissions over the period 1 April 1988 to 31 March 1989, the reductions per 1986 NAS per month ranged from $1.68 to $4.05 and $0.43 to $0.88 for the 1 January and 1 July reductions, respectively. The response to interrogatory CAC(CBTA)4Sept87-413 indicated that the latter settled revenue impacts, when expressed as a percentage of basic local single-party residential service rates, ranged from 31% to 113%. Mr. Ford's evidence indicated that the settled revenue impact of the 1 January 1987 Bell rate reductions on Québec independents, based on 1985 and 1986 data, ranged from an increase of $0.03 per NAS per month to a decrease of $2.12 per NAS per month, with an average decrease of $1.69. On average, the reduction equalled about 2.7% of total 1985 revenues. Mr. Ford's evidence and the response to interrogatory CAC(CBTA)4Sept87-407 indicated that, of 30 Ontario independents, 13 had applied to the OTSC for local rate increases and two for toll surcharges. The record also indicated that five of the applications for local increases had been granted, seven were pending and one had been denied. The Northern Telephones Ltd. application for toll surcharges had been denied and that of Manitoulin Island Telephone Company Ltd. was pending. With respect to Bell's argument that "A" commission retention rates of less than 100% result in savings to the independent's toll users which exceed the settled revenue reduction experienced by the independent company, CAC argued that toll users as a group would realize greater than average savings, while residential subscribers, who face the largest percentage increase in local rates, would realize below average savings.

CAC noted that, in the past, it has been OTSC policy to require the companies under its jurisdiction to set their MTS rates equal to Bell's. CAC noted further that, in Order 4948, the OTSC had stated that direction from the Government of Ontario would assist it in determining whether to continue that policy. Absent such a direction, CAC submitted that one must conclude from the OTSC's treatment of the toll surcharge applications before it that its policy must still be to maintain uniform toll rates throughout the province.

With respect to Bell's 12 November 1987 proposal, CAC pointed out that the revenues of the independent telephone companies would be maintained only if amendments to the traffic agreements were successfully negotiated and approved by the parties' respective regulators. In CAC's view, both the companies' ability to reach an agreement and the requirement for regulatory approval were likely to be stumbling blocks. CAC noted that the CITA panel was not optimistic that an agreement would be reached. In addition, CAC submitted that Bell's discontinuation of the Comparative Requirements Test (CRT) supplement must also be considered, as the independent telephone companies will probably want to amend the traffic agreement to take this into account. CAC argued that, even if an agreement were reached, it probably would not receive the approval of the OTSC or the Régie. In this regard, CAC noted that it was necessary to consider the joint inquiry of the OTSC and the Régie, announced by the Régie in R.S.P. 87-004-B and by the OTSC in a press release filed in this proceeding as CAC Exhibit 35, which had been initiated to analyze the traffic agreements and to determine the terms and conditions of a just and reasonable sharing of long distance revenues between provincially-regulated telephone utilities and Bell. The report of the joint inquiry is expected prior to the end of June 1988.

CAC submitted that Bell's 12 November 1987 proposal has virtually no chance of being successfully negotiated, approved by regulators or implemented in the near future. CAC argued that it would therefore be inappropriate to afford Bell's proposal any weight in assessing the impact of rate rebalancing on the independents in Ontario and Québec.

CAC submitted that Bell's rate rebalancing plan would result in significant increases in local rates for the residential subscribers of the independent companies under provincial jurisdiction. In addition, CAC was of the view that rate rebalancing could also increase pressure on the independents to sell out to Bell or other independents.

Québec-Téléphone noted that, under existing settlement arrangements, the 1 January 1987 and 1 July 1987 toll rate reductions had led to a drop in its annual revenue of $6.2 million. This represented slightly more than three percent of its total revenue. Approval of the toll rates proposed in Bell's Tariff Notice 2270A would further reduce Québec-Téléphone's annual revenues by approximately $2.4 million. The total of $8.6 million would represent approximately $3.12 per month per access line. Québec-Téléphone was of the view that Bell's rate reductions and rate rebalancing process should not affect Québec-Téléphone's revenues or subscribers in any way. Québec-Téléphone suggested two possible solutions:

i) that Bell's intra toll rates applying to Bell-to-independent traffic be frozen at 1 January 1987 levels; or

ii) that settled revenues payable to the independent companies be maintained at levels corresponding to those which would have existed if Bell's 1 January 1987 rates had been maintained.

During cross-examination by Québec, Québec-Téléphone stated that Bell's 12 November 1987 proposal for amending the traffic agreements met its request to have the company partially sheltered from the effects of any changes to Bell rates. Québec-Téléphone also expressed the opinion that an agreement could be achieved before 1 April 1988.

CITA submitted that the financial position of the independent companies under existing settlement arrangements must not be adversely affected by the toll rate reductions made under any rate rebalancing plan. CITA and OTA pointed out that many of the independent companies provide service to predominantly rural areas which have smaller bases of business subscribers and are more costly to serve. In addition, CITA and OTA noted that independent companies depend heavily on toll revenues to meet their financial requirements. CITA and OTA submitted that, if rate rebalancing were implemented, the independent companies would have to increase their local service rates to a greater extent than Bell for comparable serving areas. CITA submitted that, as a result, independents' local rates will tend to depart from Bell's as rates move towards costs. CITA noted that, because of Bell's dominance as a telephone company in Ontario and Québec, independent company subscribers and regulators tend to view Bell's rates as the standard for telephone service pricing.

With respect to Bell's 12 November 1987 proposal, OTA expressed support for the Ontario Government's policy that the entire province have access to good quality service at similar rates. OTA shared CITA's view that the rates charged by Bell tend to be regarded by independents' subscribers as the norm. OTA therefore supported the practice whereby Ontario independents adopt Bell's toll rates. Consequently, OTA was of the view that Bell's 12 November 1987 proposal offered nothing for Ontario independents. CITA was of the view that the lack of detail contained in Bell's proposal prevented any valid assessment of it.

CITA and OTA recommended that the implementation date of any Bell long distance rate changes allow sufficient time for independent companies to obtain approval from their regulators for any local service rate increases that might be required. OTA suggested an interval of six months. CITA and OTA also recommended that, should the Commission make a finding that toll rates should be reduced because of excess revenues for 1988, Bell be directed to use some of those excess revenues to compensate the independents for their reduced revenues. In addition, OTA noted that, as Bell progresses further in rate rebalancing, many more independents will find their settlements inadequate. OTA recommended that, in such circumstances where the independents' required local rate increases may be unacceptably high, Bell be directed to increase the independents' share of the toll revenues generated by their subscribers. Finally, OTA recommended that, in order to assist the independents in preparing for future Bell rate rebalancing applications and to give the Commission a better appreciation of the impact on independent companies, Bell be required to inform each independent company of the estimated impact of Bell's proposal on its revenues and to convey this information, in confidence, to the Commission.

Ontario was of the view that the effects of the proposed rate rebalancing could not be examined without a consideration of the effects of toll rate reductions on the revenues of independent telephone companies, including a consideration of methods for dealing with those effects. With respect to Bell's 12 November 1987 proposal, Ontario submitted that it would not be productive for Bell and the independents to conclude arrangements for presentation to their regulators without the benefit of any prior guidance which might be provided as a result of the joint inquiry undertaken by the Régie and the OTSC.

Ontario also opposed the discontinuation of the CRT supplement, arguing that it was the wrong time for Bell to be withdrawing this avenue of support for the independent companies. Ontario therefore requested that Bell be required to maintain the CRT supplement.

Québec supported Bell's 12 November 1987 proposal. Québec was of the view that the negotiations proposed by Bell should take place regardless of the joint inquiry undertaken by the OTSC and the Régie, not only to eliminate, at least temporarily, the negative impact on the independent companies, but also to make a positive contribution to the inquiry.

CBTA et al submitted that a decrease in settled revenues resulting from Bell toll rate reductions does not necessarily imply that the independents' overall rates of return are not satisfactory. CBTA et al noted that, as of 4 September 1987, only five Ontario independents had received approval for rate increases. CBTA et al noted that the response to interrogatory CAC(CBTA)4Sept87-412 stated that there had been no general rate filings by Québec independent telephone companies since October 1986, with the exception of an application dated 21 September 1987 by Télébec Ltée., described as being more in the nature of a rate rebalancing application.

With regard to concerns over Bell's cancellation of the CRT supplement, the company noted in reply argument that, on 3 November 1987, an agreement had been reached between Bell and CITA for a one-year trial of a new settlement method. Bell stated that this trial would be open to those companies that would have been eligible to receive a CRT supplement. During the trial, the new settlement method would be assessed and refined and other methods of settlement would be explored. A joint Bell/CITA Working Committee would develop a new settlement plan to replace the present Commission and Line-Haul agreement. Bell stated that a new, more cost-based settlement plan would more realistically meet the needs of independents that would previously have applied for a CRT supplement, and would be designed to overcome the need for such a supplement.

With respect to the position of CITA and OTA that, in the event that the Commission orders toll rate reductions due to excess revenues in 1988, Bell should be directed to compensate the independents for any resulting reduction in settled revenues, Bell stated in reply that this would place an unfair burden on Bell subscribers. Bell was of the view that, if the independents and their regulators choose to implement toll reductions equivalent to Bell's, they should also be prepared to accept the revenue impacts. Bell noted that, should an independent retain existing rates, its 12 November 1987 proposal is available. If, however, they choose to adopt Bell's toll rates, Bell noted that the reduction in toll billing would be substantially greater than the reduction in settled revenues.

'et' submitted that, before approving Bell's application, the Commission must be satisfied that independent telephone companies and their subscribers are adequately provided for in the event of rate rebalancing. 'et' expressed concern over the potential impact of Bell's rate rebalancing application on 'et' revenues through:

i) Bell rate changes for toll services whose revenues are subject to settlement arrangements;

ii) Bell rate changes causing shifts in traffic patterns that could affect allocation of revenues subject to settlement;

iii) changes to rates of other telephone companies in response to Bell rate changes; and

iv) changes to settlement agreements caused by Bell rate changes.

In reply, Bell stated its view that the record of the proceeding established that there would be no direct or indirect impact on 'et' from Bell's proposed rate rebalancing. Bell noted that the proposed rebalancing involved uniform rate changes by all the members of Telecom Canada. Bell submitted that any impact on 'et' would therefore come from the rate changes being proposed by Alberta Government Telephones. Bell noted that, should rate rebalancing proceed in such a way that the company implemented rates for Telecom Canada services that differed from those agreed to by the other members of Telecom Canada, the special settlement arrangements discussed during the proceeding would shield the other Telecom Canada members from the impact of such rate changes. Bell indicated that, in these circumstances, there would be no impact on 'et'. Bell submitted that it did not appear from the record that anything being envisaged for Bell rates in the immediate future would affect traffic patterns in Edmonton in any material way. Bell was of the view that the possibility of rate changes by other Telecom Canada members in response to Bell changes was a matter between them and their regulators.

NAPO was of the view that the Commission could neither legally nor morally consider the impact of its decisions on the independent telephone companies. NAPO submitted that when the Railway Act states that rates must be just and reasonable, it refers to the rates charged to Bell's subscribers, not to the subscribers of other telephone companies.

3) Conclusions

The Commission notes that, to the extent that toll rate reductions have an adverse impact on the independent telephone companies, it is the result of the terms of the existing traffic agreements. However, the Commission is of the view that Bell's 12 November 1987 proposal responds equitably to the concerns of the independents. Bell's proposal is similar to the Telecom Canada special settlement process, discussed during the proceeding, which is designed to accommodate non-agreed upon Telecom Canada rates. Under that process, a member reducing rates below the level agreed to by all members insulates the other members from the impact of its lower rates. Similarly, Bell is offering to leave an independent's settled revenues unchanged where that independent and its regulator choose not to match Bell's lower toll rates. However, in cases where an independent's subscribers are provided the benefits of Bell's lower toll rates, Bell's proposal provides that any necessary support for those lower toll rates would come from higher local rates. The Commission considers that it would not be appropriate to leave an independent's settled revenues unchanged in cases where it adopts Bell's lower toll rates, since doing so would result in support for the independent's lower toll rates coming from Bell's subscribers.

The Commission recognizes that Bell's proposal will be of benefit to the Ontario independents only if the OTSC allows them to charge toll rates different from Bell's. However, the Bell proposal does offer the independent telephone companies greater insulation from Bell toll rate reductions should the independents and their regulators prefer a greater degree of rating flexibility. In addition, as noted by Bell, should the OTSC and the Ontario independents prefer to maintain the existing practice of matching Bell's toll rates, the reduction in settled revenues experienced by the independents would nevertheless be smaller than the reduction in total toll billings enjoyed by their subscribers.

To facilitate implementation of Bell's proposal, the Commission has included $2.3 million in Bell's 1988 revenue requirement to allow for the estimated incremental cost to Bell of such an arrangement over the period 1 April 1988 to 31 December 1988.

With respect to Ontario's request that the Commission require Bell to main tain the availability of the CRT supplement, the Commission notes that Bell and CITA have agreed to a replacement for the CRT for the year 1988.

With regard to Québec-Téléphone's suggestion that the Bell intra toll rates applicable to Bell-to-independent traffic be frozen at 1 January 1987 levels, the Commission is of the view that the benefits of excess revenues should be enjoyed by all Bell MTS users. Therefore, the Commission considers that it would be inappropriate to freeze the levels applicable to this one type of traffic.

Concerning the suggestion of CITA and OTA that the implementation date of any Bell long distance rate changes allow sufficient time for independent companies to obtain approval from their regulators for any required local service rate increases, the Commission notes that an implementation interval would be unnecessary for independents who are able to take advantage of Bell's proposal. In any case, as this proceeding concerns Bell's revenue requirements for the year 1988, the Commission considers that it would not be appropriate to delay the implementation of reduced toll rates.

XI TARIFF REVISIONS

A. Bell Canada Tariff Notices 2270A, 2409 and 2414

1) Primary Exchange Services Rates

Bell proposed an increase of $1.25 per month for all rate groups for business individual line, two-party, four-party, PBX, message rate individual line, information system access line and foreign exchange line services. The company also proposed monthly increases of $1.25 for residence individual line and PBX services and $.80 for two and four-party residence services.

In support of the structure of the proposed increases, Bell stated that variations in costs between rate groups and between business and residence services are less than the existing variations in rate levels. Bell was of the view that, to be more consistent with costs, the existing rate differentials between low rate groups and high rate groups, and between business and residence services, should therefore be reduced. Bell noted that an across-the-board percentage increase would worsen the existing situation.

Bell further submitted that it would not be appropriate to raise business rates significantly in order to cushion the increases in residence rates. Bell was of the view that business service is compensatory in the aggregate, so that increases in local business rates would have the effect of moving those rates away from their associated costs.

Consistent with its conclusions in Part IX above, the Commission denies the proposed primary exchange services rates.

2) Local Channel Service Rates

a) Bell's Application

Bell proposed an 11% increase in local channel service rates. The company claimed that its local channel rates are below cost and that its long term objective is to make the service a profitable undertaking. Bell provided a 1983 Prospective Annualized Revenue Cost (PARC) study showing that the prospective costs of serving an increment of demand exceed existing rates.

b) Positions of Parties

CNCP opposed the proposed local channel rate increase, noting that it would result in an increase for CNCP of approximately $1.5 million in the annual cost of leasing local channels from Bell. CNCP stated that Bell gains a competitive edge by increasing CNCP's costs.

CNCP submitted that PARC studies, because they utilize prospective costs, are not suitable for use in determining whether an existing service is being provided below cost. CNCP was of the view that, in order to determine whether an existing service is compensatory, one must look at the embedded costs incurred in establishing the existing plant. CNCP submitted that the distinction between embedded and prospective costs is important because, in the case of local channels, embedded costs would be lower than prospective costs.

CNCP argued that the Commission adopted the use of prospective costs in Inquiry into Telecommunications Carriers' Costing and Accounting Procedures: Phase II - Information Requirements for New Service Tariff Filings, Telecom Decision CRTC 79-16, 28 August 1979 (Decision 79-16), only for new or substantially changed services. CNCP was of the view that, as local channel service is an existing service, the costing rules set out in Decision 85-10 are appropriate. CNCP added that even Decision 79-16 stipulated that, where existing plant is used to provide a new or substantially changed service, the existing plant is to be costed using embedded costs.

CNCP had several concerns with respect to the particular 1983 PARC study filed by Bell. CNCP was of the view that the study was outdated because it was performed in 1983. CNCP expressed concern over what it felt was inadequate documentation concerning the inclusion of signal and data channels and inside wiring investment in the 1983 PARC study. CNCP argued that, to the extent that the 1983 PARC study includes inside wiring which Bell no longer provides, it overestimates the costs associated with local channels.

CNCP noted that the proposed $1.25 increase in primary exchange rates would, in Toronto and Montreal, result in 1.8% and 3% increases in PBX trunk and individual business line rates, respectively. It also noted that the proposed local channel increase of 11% would result in a change in rate relationships between these services.

CNCP argued that, if local channel rate increases are approved, Bell should be directed to increase its rates for the enhanced services for which local channels represent an underlying basic service. In addition, CNCP submitted that, in the event the Commission considers local channel rates not compensatory, the rates for basic services which include a local channel, such as Datapac and Dataroute, should be increased in order to recognize increased local channel costs.

CBTA et al shared CNCP's view that the conclusion that local channel rates are not compensatory cannot be justified. CBTA et al raised the issue of one type of local channel, i.e., channels between buildings on continuous property. CBTA et al noted that, in Telecom Order CRTC 87-419, dated 7 July 1987, the Commission established a new rate structure for channels between buildings on continuous property. Customers with existing channels between buildings on continuous property were given the option of moving to the new rate structure or remaining with the old rate structure, which was grandfathered for those customers opting for the latter. The proposed 11% increase in local channel rates would apply to these grandfathered channels.

CBTA et al noted that Bell has argued that its rates for interexchange voice grade channels should not be reduced, because the market would not yet have stabilized after the competitive network service rate restructuring implemented on 29 September 1987 pursuant to Telecom Order CRTC 87-473, dated 31 July 1987. CBTA et al submitted that the same argument could be applied to rates for the grandfathered channels between buildings on continuous property and that therefore the proposed local channel increase should not apply to these channels.

In its reply, Bell noted that, as a result of changes to the local channel rate, CNCP's price for local channels under the local loop agreement has declined by approximately $2 million since 1985. Bell also noted that CNCP leases local channels from Bell only when it is economically advantageous for it to do so. Bell noted that, in the economic studies that the company prepares for new services in accordance with Decision 79-16, the costs employed for re-usable plant are the current costs rather than the net book value. Bell stated that this is done in recognition of the opportunity cost concept. Bell submitted that, in assessing the value of existing loop plant, opportunity cost is also the relevant cost. Bell stated that the use of an existing channel for a particular customer means that it cannot be used for another customer. Bell noted that use by the existing customer therefore causes the company to purchase or install an additional new loop in order to serve a new customer. Accordingly, Bell claimed that the current cost of a new local channel can also be viewed as being the cost of an existing local channel.

Bell was of the view that CNCP's criticism that the 1983 PARC study was outdated would not appear to affect the general conclusion of the PARC study that the cost of these channels exceeds their associated revenues, as it is likely that local channel costs have increased since 1983.

With respect to CNCP's concern about inadequate documentation, Bell noted that, as indicated in Bell Exhibits 69 and 75, the 1983 PARC study did include signal and data channels and did not include the costs of inside wiring.

Concerning CNCP's argument that local channel rate increases should result in appropriate increases in rates for enhanced services, Bell was of the view that a number of factors would have to be considered in determining what, if any, adjustments to enhanced service rates would be required. These factors would include the costs of providing the service and the availability of competitive alternatives, as well as the tariffed rates for underlying basic services. The company also noted that enhanced service economic evaluation studies include a rate adjustment factor which allows for possible future rate increases for underlying basic services.

c) Conclusions

The Commission is of the view that a number of factors must be considered in determining whether rates for local channel service are just and reasonable. Among the relevant factors is the cost of providing the service. The Commission considers that current costs are the appropriate type of costs to be used in support of rates for local channel service.

The Commission also considers, however, that the appropriate study methodology to be employed is a net present value (NPV) study which would evaluate the viability of serving total forecast demand over the study period. PARC study information indicates only the relationship between existing rates and the prospective costs of serving an increment of demand.

The Commission is of the view that, while PARC studies may provide some justification for the direction of a price change, they do not constitute conclusive evidence as to whether rates for an existing service are compensatory in the sense that they are greater than or equal to the causal costs of providing the service. Accordingly, the Commission is of the view that there is not sufficient justification for the proposed local channel rate increase and considers that existing rate relationships between business primary exchange service and local channels should be maintained. The Commission therefore denies the proposed local channel rate increase. With respect to CNCP's suggestion that, as local channel service is an existing service, the costing approach established in Decision 85-10 is appropriate, the Commission notes that the objective of the methodology established in that decision is to determine the revenues and revenue requirement costs associated with broad service categories only.

3) Centrex Rates

In Tariff Notice 2270A, Bell proposed a Centrex rate increase of $0.10 per local. Bell stated that this increase would maintain rate relationships with primary exchange service. In Bell Exhibit 54, the company amended its proposed Centrex increase. Although local distance charges were used in the original development of Centrex III rates for both single and multiple wire centre services, the company did not take the proposed local channel increases into account in developing the proposed Centrex increases. Bell Exhibit 54 reflected the proposed local channel increases by modifying the $0.10 per local rate increase to $0.25 and $0.50 per local increases for single and multiple wire centre services, respectively.

The Commission is of the view that Centrex rates should be set so as to maximize contribution. The Commission notes that the introduction of Centrex III was approved on the basis of an economic evaluation study for which the NPV was calculated assuming specific yearly Centrex III revenue increases arising from rate increases. The Commission notes further that no rate increases have taken place.

In response to interrogatories Bell(CRTC)20Mar87-722, Bell(CRTC)11May87-1711 and Bell(CRTC)8Sept87-3701, the company indicated that, under a number of rate scenarios provided by the Commission, Centrex revenues would be maximized by a $0.42 per local increase.

In light of Centrex III tracking data, the absence of any increase in Centrex III rates as assumed in the initial economic study, and the company's responses to interrogatories, the Commission hereby prescribes a $0.42 per local increase in Centrex I, II and III services and in Enhanced Exchange Wide Dial Service.

4) Other Exchange Services

Bell proposed increases to rates for other exchange services which were designed to maintain rate relationships with primary exchange service. These increases were $0.10 increases per month in short-term and service-system services, a $0.05 increase per day in semi-public daily guarantee and a $0.005 increase per message in the local message charge. Consistent with its conclusions in Part IX above, the Commission denies these proposed increases.

5) Service Charges

Bell proposed increases to its multi-element service charges in order to more closely reflect the estimated causally related costs of performing the work functions. Consistent with its conclusions in Part IX above, the Commission denies the proposed increases.

6) MTS/WATS/800 Service Rates

a) Bell's Application

(1) TransCanada Message Toll Service

Bell proposed the following changes to TransCanada MTS rates:

i) the elimination of non-discountable, distance-sensitive three minute initial period rates for operator assisted calls;

ii) the introduction of non-discountable surcharges of $1.50 and $3.75 for station operator handled and person-to-person calls, respectively;

iii) the introduction of per minute usage rates common to all types of calls;

iv) reductions in base usage rates for calls over 111 miles averaging 11.2% for all mileage bands, with greater reductions in higher mileage bands;

v) the permanent introduction of the 11 PM start time for the deep discount period;

vi) the application to base usage rates of time of day discounts to all minutes of all calls; and

vii) the termination of the trial of a $0.59 per minute rate cap on customer-dialed calls made during the 35% discount period.

Bell stated that the impact of these revisions would be an average price reduction of 8.1%. Items i) to vi) were granted interim approval, effective 1 July 1987, in the Commission's letter to the company of 23 June 1987.

Bell was of the view that the establishment of operator surcharges and per minute usage rates would better reflect the nature of the costs involved in providing operator handled calls and would result in a simplified message toll schedule that is easier for customers to understand. Bell noted that the resulting structure would be similar to the intra-Bell and Canada-U.S. MTS toll schedules prescribed in Decision 86-17.

With respect to its proposal that long haul rates be reduced by more than short haul rates, Bell submitted that long haul rates are more out of line with costs.

Concerning the proposal to terminate the $0.59 per minute rate cap, Bell stated that it had preferred retaining the cap until such time as further reductions to base usage rates rendered it unnecessary. However, some other Telecom Canada members were not prepared to accept the greater revenue reductions associated with its retention. Bell therefore agreed to the termination of the cap in the context of the negotiated Telecom Canada rate reductions.

(2) Canada WATS - Non Intra Zones

Bell proposed decreases for WATS 10 and 5 hour service classes to reflect the lower proposed TransCanada business day customer-dialed MTS rates. The proposed reductions applied to both initial period and additional usage rates.

Bell also proposed WATS 120 initial period rate revisions that were designed to result in a cross-over level of 95 hours between WATS 120 and WATS 10. The current cross-over level is 85 hours. Bell stated that the combined effect of the higher cross-over and the lower proposed WATS 10 rates would be increases in some WATS 120 initial period rates and decreases in others.

For usage beyond 120 hours, the current additional usage rate provides for a discount of 44% from the current WATS 120 initial period equivalent hourly rates. Bell proposed revised additional usage rates providing for a 40% discount.

Bell stated that the proposed WATS rate revisions were designed to maintain a level approximately equivalent to business day customer-dialed MTS for the WATS 10 hour initial period rates, and to encourage low volume WATS 120 users to migrate to WATS 10, thereby facilitating the eventual elimination of the WATS 120 service class.

The proposed rates would result in average effective reductions of 6.6% and 0.6% for WATS 10/5 and 120, respectively.

In addition, minor modifications to the definitions of Zones 3 and 4 for most Bell numbering plan areas (NPAs) were proposed. These changes would increase the calling scope of the zone 3 coverage area.

(3) Canada 800 Service - Non Intra Zones

For zones 4 and 5, Bell proposed revised initial period rates for 5 hour 800 Service which would preserve the existing 5% premium over TransCanada business day customer-dialed MTS rates. For Zone 6, Bell proposed 5 hour initial period rates which represent a 10% premium over customer-dialed MTS rates, in recognition of the Canada-wide coverage available with Zone 6 lines. Under Bell's proposal, the 5 hour initial period rates would decrease for some zones and remain unchanged for others.

The current 5 hour service additional usage rates provide for a 20% discount from the initial period equivalent hourly rates.

Bell proposed additional usage rates providing for a 15% discount, resulting in a rate increase. Bell stated that the use of the 15% discount extends the recognition of the premium value of Canada 800 Service to the additional usage rates.

Regarding the large volume 800 Service, Bell proposed a reduction in the initial period allowance from 160 hours to 140 hours and increases in the initial period rates. These changes, combined with the proposed 5 hour service rates, would result in an increase from 75 hours to 80 hours in the cross-over level between the 5 hour service and the 160/140 hour service. The current 160 hour additional usage rates provide for a discount of 25% from the initial period equivalent hourly rate. Bell proposed that the discount be increased to 30%. In addition, Bell proposed that additional usage be rated in increments of 1 hour rather than at the current increment of 5 hours.

Bell also proposed that, for both the 5 hour and 140 hour services, additional usage be billed to the nearest minute.

Bell stated that the proposed Canada 800 Service rate changes were designed to recognize the premium value of 800 Service, to encourage low volume users of 160 hour Canada 800 Service to migrate to the 5 hour service and to provide for more usage sensitive rates.

Bell's proposal would result in average effective price increases of 1.1% and 13.8% for the 5 hour and 160/140 hour services, respectively.

In addition, minor modifications to the definitions of Zones 3 and 4 for most Bell NPAs were proposed. These changes would increase the calling scope of the Zone 3 coverage area.

(4) Canada-U.S. 800 Service

Bell proposed revisions to its Canada-U.S. 800 Service rates to reflect the Canada-U.S. MTS rate restructuring prescribed by the Commission in Decision 86-17 and to increase the premium of Canada-U.S. 800 Service rates over MTS rates. In the past, Canada-U.S. 800 Service rates have been set at a 5% premium over Canada-U.S. customer-dialed business day MTS rates. Bell proposed rate revisions resulting in a 10% premium for Zones 1 and 2 and a 15% premium for Zone 3. This resulted in various rate increases and decreases producing an average effective reduction of 1.1%.

(5) Intra-Bell Message Toll Service

Bell's proposed reductions in intra-Bell message toll base usage rates for calls beyond 40 miles averaged 4.3% over all miles, with greater reductions in the long haul than in the short haul. In the interim rate decision, the Commission granted interim approval, effective 1 July 1987, to rate revisions which reduced base usage charges by an average of 2.8%. Bell's rationale for the greater long haul reductions was that long haul rates are more out of line with costs than short haul rates.

Bell also proposed the introduction of a 60% discount on Saturday morning, 8 AM to noon, and an increase from 33 1/3% to 35% in the discount during the period Monday to Friday, 6 PM to 11 PM. Bell stated that the proposed changes to the Saturday morning discount period were expected to increase network utilization on Saturday mornings and to distribute the traffic more evenly throughout the weekend. The proposed changes in the discount periods were approved in the interim rate decision.

Bell indicated that the combined effect of the proposed intra-Bell MTS rate revisions would be an average rate reduction of 5.8%.

(6) Canada WATS - Intra Zones

Bell stated that the objectives for the proposed intra WATS rates are similar to those noted for non-intra zones. Bell proposed WATS 10 initial period rates at a level approximately equivalent to business day customer-dialed MTS rates.

Bell proposed reductions in intra WATS 120 initial period rates designed to result in an increased cross-over level between WATS 120 and WATS 10 of 125 hours. Bell stated that the higher cross-over level is consistent with the objective of moving ultimately to a single class of WATS. Bell stated that without the WATS 120 initial period reductions, the cross-over level would increase to 140 hours. Bell was of the view that it was desirable to ensure that those users with volumes well above average and who provide substantial revenue to the company would share some of the benefits of significant decreases in toll service rates.

Bell proposed WATS 120 additional usage rates which would provide for a discount of 40% from the initial period equivalent hourly rate.

Bell's proposal would result in average effective rate reductions of 7.2% and 6.5% for WATS 10/5 and WATS 120, respectively.

(7) Canada 800 Service - Intra Zones

Bell proposed revisions in the intra 5 hour 800 Service rates which would establish initial period rates at a 15% premium over MTS rates and reduce the additional usage discount from 20% to 15%.

Bell also proposed that the initial period allowance for the 160 hour service be reduced from 160 hours to 140 hours, as it had proposed for the service in non-intra zones.

Currently, additional usage on the large volume service is rated in 5 hour increments. Bell proposed that additional usage be rated in one hour increments equal to the current additional usage equivalent hourly rate.

The proposed changes would result in an average effective price reduction of 17.1% for the 5 hour service and an average effective price increase of 3.4% for the 140 hour service.

As for the non-intra zones, Bell proposed that additional usage be billed to the nearest minute on both the 5 hour and 140 hour services.

(8) WATS/800 Service Customer Impact

Bell indicated that 75.8% of WATS customers would experience a reduction in their bills under the proposed rates. The remainder would experience increases ranging up to 10%.

Bell indicated that 87.5% of 800 Service customers would experience a reduction in their bills under the proposed rates. Approximately 10.1% would experience increases ranging up to 5%. The remaining 2.4% would experience increases greater than 5%.

b) Positions of Parties

With respect to its objective of moving to a single class for each of WATS and 800 Service, Bell stated that a single class of service would provide a number of benefits to customers as well as to the company. Bell was of the view that a single class of service that provides a gradual increase in savings as usage increases would be preferable to the present scheme whereby savings increase only after a high level of usage has been attained and the customer has been required to change to the other class of service. Bell stated that, with the present two classes of service, customers must constantly assess their usage to determine if they should switch classes in order to maintain the most economical service or mix of services. Bell noted that a single class of service would remove the need to change service classes, thereby eliminating the need to apply service charges. The company stated that it would benefit from a single class of service, as administration of the service would be simplified.

Concerning MTS rate revisions, the Director was of the view that future applications for non-uniform price changes should be supported by evidence on price elasticity of demand by mileage band.

CBTA et al submitted that the proposed increases in WATS and 800 Service rates violate the policy considerations which support the idea of rate rebalancing. CBTA et al noted the Commission's emphasis in Decision 85-19 on the importance of reducing communications costs for Canadian business. CBTA et al also noted that some users of WATS and 800 Service would experience an increase in their rates.

CBTA et al objected to Bell's objectives of encouraging migration from WATS 120 and 140 hour 800 Service to WATS 10 and 5 hour 800 Service and of ultimately moving to a single class of service for each of WATS and 800 Service. CBTA et al was of the view that Bell had not adequately justified these objectives.

CBTA et al submitted that the benefits to Bell of moving to a single class of service would be relatively minor because Bell would still have to bill customers, respond to orders and carry out usage studies. CBTA et al also submitted that any savings to customers as a result of moving to a single class of service would be insignificant compared to the increased expenditures that high volume users would face as a result of the elimination of WATS 120 and 140 hour 800 Service. CBTA et al noted that B.C. Tel had no plans to phase out WATS 120. CBTA et al submitted that the proposed 125 hour cross-over level between intra WATS 10 and WATS 120 would move Bell close to its objective of phasing out WATS 120 in intra-company zones.

CBTA et al submitted that the reduction in the additional usage discount for WATS 120 in non-intra zones would not affect migration to WATS 10 because the proposed cross-over level is 95 hours. CBTA et al submitted that the decrease in discount is therefore simply a rate increase.

CBTA et al noted that customers with large numbers of 160 hour 800 Service lines are often customers with national reservation systems, such as hotels or airlines. CBTA et al stated that, as domestic U.S. 800 Service is considerably cheaper than Canada 800 Service, there is already a strong incentive for customers wanting North American coverage to base their reservation centres in the U.S. CBTA et al submitted that an increase in Canada 800 Service rates would provide an incentive for the customer to close down its Canadian operations and operate the reservation system for both Canada and the U.S. out of the American centre.

CBTA et al was of the view that the Commission should not approve any increase in WATS or 800 Service rates, but should order that those rates for which Bell has proposed an increase remain unchanged. CBTA et al requested that the Commission direct Bell to alter its rating plans so that WATS 120 and the large volume 800 Service would not be phased out. In addition, CBTA et al submitted that the 160 hour 800 Service initial period should continue to be 160 hours.

CBTA et al submitted that domestic U.S. 800 Service and Canada-U.S. private lines are a readily available substitute for Canada-U.S. 800 Service. CBTA et al was of the view that Bell did not give sufficient attention to this competitive alternative in proposing rate changes for Canada-U.S. 800 Service. CBTA et al submitted that the proposed Canada-U.S. 800 Service rate increases should be denied.

In its reply argument, Bell stated that, as rates move closer to costs, the savings available at higher levels of usage must be reduced relative to those available at lower levels of usage. Bell noted that the high levels of savings available to large customers who can take advantage of WATS 120 and 160/140 hour 800 Service are not currently available to smaller customers. With respect to the reduction in the WATS 120 additional usage discount from 44% to 40%, Bell stated that the proposed change would have little impact on the customer's total bill, in light of other toll service reductions. Bell stated further that the reduction in discount would allow for future changes that also were small, yet consistent with the objective of eventually moving to a single class of service.

With regard to the impact of the proposed Canada 800 Service rates on customer decisions to move their Canadian operations to the U.S., Bell referred to Bell Exhibit 67. This exhibit indicated that, for large volume customers, AT&T Cross-Border 800 Service can be more expensive than Canada 800 Service at proposed rates. Bell therefore expressed the view that it did not consider the possibility of customers moving their Canadian operations to the U.S. as a result of the proposed rate changes to be a threat at this time.

c) Conclusions

Regarding the Director's submission that future applications for MTS rate changes varying by mileage band should be supported by evidence on price elasticity of demand by mileage band, the Commission is of the view that MTS rate changes varying by mileage band can be justified on the basis of costing information such as that filed by Bell in this proceeding. However, as noted in the section on price elasticity of demand, the Commission recognizes the value of developing price elasticity estimates based on models disaggregated to the extent that they can produce useful and desired information.

With respect to TransCanada MTS rates, the Commission grants final approval to the rates approved on an interim basis under Tariff Notice 2409. However, the Commission does not consider that termination of the $0.59 per minute rate cap on customer-dialed calls during the 35% discount period would be appropriate. Therefore, the proposed termination of the cap is denied.

With respect to intra-Bell MTS rates, the Commission grants final approval to the introduction of the 60% discount on Saturday morning and the increase in the discount from 33 1/3% to 35% during the period Monday to Friday, 6 PM - 11 PM. The Commission considers it appropriate that, in recognition of costs, the intra-Bell MTS usage rate reductions be greater in the long haul than in the short haul, and therefore approves the proposed intra-Bell MTS usage rates.

Concerning the proposed WATS and 800 Service rates, the Commission notes Bell's response to interrogatory Bell(CRTC)8Sept87-3709, in which the company submitted that the rates for WATS and 800 Service should be consistent with the objective of maximizing contribution. The Commission is of the view that this approach is appropriate because it passes on the benefits of toll contribution reductions to as many users as possible. As a result, small as well as large users can benefit from low toll rates.

The Commission agrees with Bell that, as toll rates move towards costs, it is appropriate that the levels of discount available at higher levels of usage be reduced relative to those available at lower levels of usage. This view is consistent with the Commission's position in Decision 86-17, in which it prescribed a 20% reduction in the proposed intra-Bell MTS usage rates, a 15% reduction in the proposed intra-Bell WATS 10 rates and no reduction in the proposed intra-Bell WATS 120 rates. In this regard, the Commission stated:

Whereas MTS is used by both residence and business subscribers, WATS, which provides discounts in relation to MTS, is used almost exclusively by business subscribers. In light of these two factors, the Commission does not consider it appropriate for the WATS rate reductions directed to be made in this decision to be as large as those for MTS.

While the Commission recognizes that an important benefit of toll contribution reductions is the reduction of communications costs for business, the Commission does not consider that pursuit of this objective precludes an otherwise justified restructuring of rates within the toll category. Such a restructuring may have the effect of decreasing rates for some business users by more than the average toll rate reduction; for other business users by more than the average toll rate reduction; for other business users, it may result in rate increases or in decreases that are less than the average toll rate reduction.

The company's other objectives for WATS and 800 Service were to increase the usage sensitivity of rates, to encourage migration from WATS 120 and 160/140 hour 800 Service to WATS 10 and 5 hour 800 Service and ultimately to move to a single class of WATS and 800 Service. Consistent with its conclusions in Decision 86-17, the Commission considers that these objectives are appropriate for both WATS and 800 Service.

The Commission notes Bell's view that, because many existing customers have WATS lines to both intra and non-intra zones, it would be appropriate to phase out the WATS 120 class of service for intra zones and non-intra zones over the same period of time. Bell was also of the view that even a cross-over level between WATS 120 and 10 of 125 hours provided sufficient incentive for many customers to migrate to WATS 10. In the Commission's view, however, the proposed intra-Bell WATS 120 rates are not consistent with the need to reduce large volume discounts as rates move towards costs. On balance, the Commission considers that this consideration outweighs those raised by Bell.

With respect to CBTA et al's position that Bell has not adequately considered the impact of the proposed Canada 800 Service rates on customers' decisions to move reservation centres from Canada to the U.S., the Commission considers that, in many cases, that decision will be influenced by the relationship between the costs of serving the Canadian originated traffic on Canada 800 Service and the costs of serving that traffic on AT&T's cross-border 800 Service. As noted previously, Bell Exhibit 67 indicates that, under the company's proposed rates, the former can be less expensive than the latter for large volume applications. Accordingly, the Commission does not consider that the proposed Canada 800 Service rates will result in significant 800 Service revenue erosion due to the relocation of customer reservation centres.

With respect to CBTA et al's submission that, in proposing Canada-U.S. 800 service rate changes, Bell did not give sufficient attention to the use of domestic U.S. 800 Service in conjunction with Canada-U.S. private lines as an alternative to Canada-U.S. 800 Service, the Commission notes Bell's statement that approximately 70% of Canada-U.S. 800 Service customers use Zone 3 lines, for which rate reductions are proposed. Most of the proposed increases are between 4% and 6%, the exceptions being 9.4% and 17.2% increases in two Zone 1 services. Given the recent increases in short haul Canada-U.S. MTS and private line rates, the Commission is of the view that the increases proposed for Canada-U.S. 800 Service are not likely to cause significant Canada-U.S. 800 Service revenue erosion.

Therefore, the Commission grants approval to the proposed Canada WATS, Canada 800 Service and Canada-U.S. 800 Service rates, with the exception of the proposed WATS 120 rates for intra zones, which are denied.

In addition, the Commission approves the proposed modifications to the definitions of Zones 3 and 4 for WATS and 800 Service and the proposal to bill 800 Service additional usage to the nearest minute.

B. Other Rates Issues

1) Interexchange Voice Grade Channel (IXVG) Rates

Bell indicated that it had considered proposing changes to the rates for competitive network services as part of its rate rebalancing application, but had chosen not to revise those rates until the rates approved in CRTC Telecom Public Notice 1986-42, dated 3 July 1986, had been implemented and the market had had an opportunity to stabilize. The company stated that its IXVG rates are not based solely on maintaining specific relationships with MTS rates. The company further stated that the impacts of sharing and resale in the private line marketplace, the introduction of new technologies and the lowering of toll rates would be monitored in order to determine if IXVG rates should be reduced in subsequent phases of rebalancing.

B.C. Tel's position was that, because of the recent rate restructuring, further changes to IXVG rates were not necessary at this time. B.C. Tel was of the view that the reduction of private line rates at this time would not be consistent with the objective of maximizing contribution from its competitive services.

CBTA et al stated that, in past rate cases, increases in MTS rates had generally been accompanied by increases in private line rates with the result that cross-over relationships with MTS had been maintained. CBTA et al submitted that private line users are sophisticated enough to have adjusted to the resale and sharing rate restructuring and the introduction of new services. CBTA et al was of the view that the effect of an IXVG rate reduction would be understood and that rate reductions would make the service more attractive, resulting in increased demand for it. CBTA et al stated that lower IXVG rates would be more in line with lower IXVG rates in the U.S. CBTA et al submitted that Bell's and B.C. Tel's IXVG rates should be reduced to maintain the cross-over relationships between IXVG and MTS rates that existed prior to 1 July 1987.

The Commission is of the view that rates for competitive network services should maximize contribution. Based on the record of this proceeding, there is no evidence to suggest that rate reductions would increase the contribution from these services.

2) Failure by Bell to Conform to its Tariffs

In response to interrogatory Bell(CBTA)8Sept87-717, Bell provided a list of cases during 1986 and 1987 in which products or services were provided at rates, or on terms and conditions, other than those specified in the company's approved tariffs. There were 16 categories of variances from the tariffs, covering a total of 1,758 cases and involving a negative revenue impact of about $1.1 million. Mr. Farrell indicated that there were three cases concerning Megastream service where Bell, in order to attract a customer, had offered to provide and charge for less than the four channel minimum specified in the General Tariff. There were numerous other cases where Bell waived or rebated charges, including termination charges on competitive terminal equipment, for reasons such as customer dissatisfaction with equipment performance, major technical, service or repair problems, unsatisfactory system design, missed due dates, and system expansions beyond the initial sales recommendation.

Bell noted that it handles several hundred thousand transactions in the course of a year. Bell stated that the small number of violations indicates that the company is concerned, takes its responsibilities in ensuring adherence to its tariffs very seriously, and has established processes to ensure that those tariffs are followed.

CBTA et al noted that the deviations from the tariffs tend to occur in cases where Bell is offering competitive goods and services. CBTA et al took the position that deviations from the tariffs are acceptable where, for example, equipment has not performed satisfactorily, but that Bell should not deviate from the tariff in order to win a bid in a competitive environment. CBTA et al further submitted that the Commission should direct Bell to file a follow-up report regarding its practices in deviating from its tariffs.

In reply, Bell stated that the violations identified in response to interrogatory Bell(CBTA)8Sept87-717, when viewed in the context of the several hundred thousand transactions the company processes each year, should not be regarded as a problem that justifies follow-up action by the Commission at this time.

The Commission is of the view that it would be acceptable for Bell to waive tariffed charges in the event of technical difficulties which have prevented the use of the service or equipment by the customer. In such a case, Bell would not have provided the service or equipment specified in the tariff. In the event that the technical difficulties were subsequently corrected, the Commission considers that it would not be acceptable to waive, for instance, initial installation charges, in order to ease customer dissatisfaction. The Commission notes that making a firm quote that deviates from the approved tariff in order to win a competitive bidding process would constitute a contravention of the Railway Act (the Act).

The Commission does not accept Bell's submission regarding the number of cases of variances identified in response to interrogatory Bell(CBTA)8Sept87-717. Any situation in which Bell offers or provides equipment or services at rates or under terms and conditions other than those specified in its approved tariffs constitutes a contravention of the Act. The Commission notes that, under sections 343(1), 376(1), 380 and 395, it can prosecute Bell, its directors or its officers for violations of the Act.

Therefore, the Commission directs Bell to file semi-annual reports documenting all cases during the previous six months in which products or services have been provided at rates, or on terms and conditions, other than those set out in the company's approved tariffs. The filing of these reports shall continue until such time as the Commission is satisfied that they are no longer necessary. For each category of variance, the reports shall provide a description of the variance, the reasons for the variance, the number of cases, the approximate revenue impact and a detailed description of the steps taken by the company to ensure no repetition of the variance. The first report shall also provide a description of the remedial action taken by the company concerning the variances from the tariff described in response to interrogatory Bell(CBTA)8Sept87-717. The first report shall be filed with the Commission by 15 August 1988 and shall cover the period from 1 January 1988 to 30 June 1988.

C. B.C. Tel Tariff Notices 1555 and 1555A

Under Tariff Notice 1555, B.C. Tel proposed revisions to its tariffs for TransCanada MTS, WATS and 800 Service that were comparable to those proposed by Bell under Tariff Notice 2270A. The Commission approved, effective 1 July 1987, the revisions to B.C. Tel's TransCanada MTS rates, with the exception of the discontinuation of the $0.59 per minute rate cap, proposed under Tariff Notice 1555A.

B.C. Tel stated that it did not favour retention of the $0.59 cap, which had failed to meet revenue objectives.

Consistent with the discussion above with respect to Bell Tariff Notices 2270A and 2409, the Commission grants final approval to the TransCanada MTS rates proposed under B.C. Tel Tariff Notices 1555 and 1555A, with the exception of the termination of the $0.59 per minute rate cap, which is denied. The Commission also grants approval to the WATS and 800 Service rates proposed under Tariff Notice 1555.

D. Tariff Filings

Bell is directed to issue revised tariff pages within 10 days, with an effective date of 1 April 1988, to give effect to the rate changes specified in this decision.

B.C. Tel is directed to issue revised tariff pages within 10 days, with an effective date of 1 April 1988 for MTS rate revisions and 19 April 1988 for WATS and 800 Service rate revisions, to give effect to the rate changes specified in this decision.

XII FOLLOW-UP ITEMS

A. Status of Items Identified in this decision 86-17

The Commission has reviewed the follow-up items arising from Decision 86-17 and has determined that all such items have either been completed or subsumed in another proceeding.

B. Summary of Items Identified in this Decision

The Commission has identified the following as follow-up items to this decision:

88-04:01 - Report on Internal Control Procedures for Excluded Trouble Reports (page 21)

88-04:02 - Report on Forecasting of Non-Penetration Lines (page 41)

C. Follow-up Procedure

The Commission intends to deal with the foregoing follow-up items in accordance with the following procedure:

(a) Any intervener who wishes to receive copies of documents relating to follow-up items should register with the Commission by letter specifying the follow-up items of interest by 18 April 1988.

(b) The Commission will compile a list of parties who have registered noting the follow-up items of interest to each party and will provide a copy of this list to each registered party.

(c) Subject to subparagraph (f), a copy of each document filed with the Commission shall be sent to each party registered for the particular follow-up item.

(d) Parties may comment on any document within thirty days from the date of filing. A copy of comments shall be sent to the Commission and to each party registered for the follow-up item.

(e) Bell may reply to comments within ten days from the date of their receipt.

(f) The provisions of section 19 of CRTC Telecommunications Rules of Procedure apply to any claim of confidentiality. In addition, a party asserting such a claim shall send, to each party registered for the particular follow-up item, a copy of the claim and supporting reasons.

Please note that interveners who do not register pursuant to these procedures will nevertheless have access to the relevant documents by consulting the public files of the Commission in its public examination rooms located in Room 201 of the Central Building, Les Terrasses de la Chaudière, 1, Promenade du Portage, Hull, Québec, or Complex Guy-Favreau, East Tower, 200 Dorchester Blvd. West, 6th Floor, Montréal, Québec.

Fernand Bélisle
Secretary General