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Decision

Ottawa, 25 January 1995
Telecom Decision CRTC 95-1
QUÉBEC-TÉLÉPHONE - DEVELOPMENT PLAN FOR 1995-1999 AND REVENUE REQUIREMENT FOR 1995
Table of Contents
OVERVIEW iii
I INTRODUCTION 1
II QUALITY OF SERVICE 3
III CONSTRUCTION PROGRAM 4
A. Construction Program Overview 4
B. Economic Justification for Major Programs 7
C. Future Submissions 9
D. Conclusions 10
IV EXTENDED AREA SERVICE 10
A. General 10
B. Exceptions to EAS Criteria 12
V REGULATORY ADJUSTMENTS AND ACCOUNTING MATTERS 15
A. Determination of Working Capital 15
B. Les Annuaires du Québec Enr. - Integrality 17
C. Les Annuaires du Québec Enr. - Regulatory Adjustment Enr. 19
D. Investment in Alouette Telecommunications Inc. 21
E. Accounting Reserve Balance 22
VI OPERATING EXPENSES 24
A. Adjustment of 1995 Forecast as per Year-to-Date Update of  1994 View 24
B. Stentor Expenses 25
C. Productivity and Forcasting Accuracy 26
D. Depreciation 30
E. Conclusions 30
VII OPERATING REVENUES 31
VIII RATE OF RETURN ON AVERAGE COMMON EQUITY 32
IX METHOD OF REGULATION AND REVENUE REQUIREMENT 36
A. Method of Regulation 36
B. Revenue Requirement 37
C. Interim Rates and the Effective Date of New Rates 39
X TARIFF REVISIONS 41
A. Provision for Toll Rate Reductions 41
B. Provision for Additional Revenues from Optional Services 43
C. Reduction to Off-Peak Discounts for Basic Toll Rates 43
D. Restructuring of Rates for Local Circuits 44
E. Local Rate Restructuring and Local Rate Increases 45
F. Other Issues Raised by Interveners 50
G. Filing of Tariff Pages 51
OVERVIEW
(Note: This overview is provided for the convenience of the reader and does not constitute part of the Decision. For details and reasons for the conclusions, the reader is referred to the various parts of the Decision.)
In this Decision, the Commission, among other things:
(1) found Québec-Téléphone's planned construction program to be reasonable;
(2) altered the Extended Area Service requirements for links to non-Bell Canada exchanges to provide that the Community of Interest requirements have only to be met for two months out of twelve and that a vote is only required where the individual-line residential monthly increase is greater than one dollar;
(3) reduced Québec-Téléphone's 1995 Operating Expense forecast by $3.5 million;
(4) approved a rate of return on average common equity (ROE) for Québec-Téléphone in the range of 11.25% to 12.25% for 1995, and estimated that the company would require additional revenues of $3.7 million in 1995 in order to earn the midpoint of its approved ROE range, i.e., 11.8%;
(5) approved a provision of $3.5 million for toll rate reductions in 1995, with $1.7 million of that amount to be provided from the balance of the accounting reserve;
(6) denied proposed changes to off-peak toll discounts;
(7) approved the proposed local rate group compression from four rate groups to two, for both residence and business customers; and
(8) approved, effective 1 January 1995, monthly local rate increases averaging 4.2% for residence customers and 6.0% for business customers.
I INTRODUCTION
Québec-Téléphone prepared its Development Plan for 1995-1999 in accordance with the requirements of the Régie des télécommunications du Québec (the Régie) with the intention of filing it with the Régie on 13 May 1994. Under the Régie's direction, the company was required to file a Development Plan annually, providing the company's construction program on a five-year prospective basis and indicating any changes from the previous year's plan. As well, the Development Plan was required to contain a rationale for any proposed changes to the company's allowed range for its rate of return on average common equity (ROE), and to provide economic and financial information in support of any local rate increases. The Development Plan that Québec-Téléphone intended to file with the Régie was referred to as the March 1994 Edition.
Following the 26 April 1994 decision of the Supreme Court of Canada in Attorney General of Quebec et al. v. Téléphone Guévremont Inc., by virtue of which the Commission assumed jurisdiction over Québec-Téléphone and the other independent telephone companies in Canada, it became necessary for the company to file its Development Plan with the Commission, rather than with the Régie.
On 7 July 1994, Québec-Téléphone filed its 1995-1999 Development Plan. In its submission, the company advised that, subsequent to the Supreme Court decision referred to above, the dates of several filings were moved forward, affecting financial data in its Development Plan, as well as its annual budget. Accordingly, the Development Plan filed on 7 July 1994 included an update referred to as the June 1994 Revision.
Québec-Téléphone's Development Plan for 1995-1999 included a proposal to restructure its local rates by merging four rate groups into two, as well as proposed local rate increases for residence and business customers, effective 1 January 1995. In total, the rate restructuring and rate increases were estimated to represent an average 11.2% increase in local rates and an increase of 11.6% in regional supplement rates, applicable in those exchanges with Extended Area Service (EAS).
On 17 October 1994, the Commission held a regional hearing in Rimouski, Quebec, to allow interveners an opportunity to provide oral and/or written comments concerning proposals in Québec-Téléphone's Development Plan for 1995-1999. Commissioners Fernand Bélisle (chairman of the hearing), Yves Dupras and Claude Sylvestre presided. The following interveners appeared or were represented at the hearing: the Corporation de développement économique de Saint-Augustin-de-Desmaures, the Centre local des services communautaires de Témiscouata, the City of Murdochville, Révérend Père Wilfrid Desrosiers, the Chamber of Commerce of Sainte-Claire, Le Comité du 642, Mr. François Langlois (député fédéral de Bellechasse et leader-adjoint de l'opposition officielle), and Mr. Paul-Émile Saint-Laurent. The Commission also received written comments from the ministère de la Culture et des Communications, gouvernement du Québec (Government of Quebec), as well as 21 letters of intervention. On 24 October 1994, Québec-Téléphone filed a written response.
The Commission notes that the Régie regulated the rate of return of Québec-Téléphone's monopoly operations only. In order to facilitate the transition from provincial to federal regulation, the Commission accepts, for the purpose of determining the company's revenue requirement for 1995, the methodology used by the company in its filings with the Régie.
II QUALITY OF SERVICE
In its submission, Québec-Téléphone proposed changes to its quality of service indicators and standards previously reported to the Régie. The company considered these changes to be minor, and advised that it did not believe it necessary to wait for approval of the Development Plan before proceeding with them.
No party commented on the company's proposal.
The Commission notes that Québec-Téléphone is a party to the proceeding initiated by Review of the Quality of Service Indicators, Telecom Public Notice CRTC 94-50, 21 October 1994. The Commission considers that, since the company's quality of service indicators will be reviewed as part of that proceeding, the company, in the interim, may file Quality of Service reports which reflect its proposed changes.
III CONSTRUCTION PROGRAM
A. Construction Program Overview
Québec-Téléphone's five-year construction program (the 1995-1999 capital plan) forecasts total expenditures of approximately $379 million for the forecast period. The forecast annual expenditures by usage categories are as follows:
Category 1995 1996 1997 1998 1999 TOTAL
($ Millions)
Basic Telephone Service 26.9 33.2 34.1 35.3 34.2 163.7 (43%)

Modernization 14.9 22.0 21.8 27.4 30.2 116.3 (31%)
Service Improvements 8.6 13.3 10.7 9.0 11.6 53.2 (14%)
Network Improvements/ 4.5 3.8 2.5 6.8 9.9 27.6 (7%)
Buildings, Vehicles and Tools 3.9 4.0 3.4 3.3 3.3 17.9 (5%)
Total 58.8 76.3 72.5 81.8 89.2 378.7 (100%)
(Totals may not sum due to rounding.)
The Basic Telephone Service category comprises expenditures for projects that are necessary to provide and maintain network plant or equipment to meet current and projected demand for existing telecommunications services. The Modernization category includes expenditures for projects that replace obsolete plant facilities and equipment with modern technology. The Service Improvements category covers expenditures for projects that are undertaken to provide new or improved customer services. The Network Improvements category includes expenditures for projects that are undertaken to improve the operating efficiency of the company. The Buildings, Vehicles and Tools category relates to expenditures for projects required to provide and maintain facilities or equipment necessary to support the company's operational needs.
Québec-Téléphone provided forecast expenditure data comparing the 1995-1999 capital plan to the previous 1994-1998 capital plan for each of the common years 1995 to 1998.
The Commission notes that the view-over-view expenditure variances for 1995 and 1996 are mainly due to the addition of new projects, advancements and deferrals of some existing or previously planned projects, delays in technological developments and the upgrading of certain switch application software. Québec-Téléphone provided detailed explanations of the impact of all major projects on 1995 and 1996 expenditure variances and quantified the amount of variance for each project. The Commission considers the company's explanations of view-over-view expenditure variances satisfactory.
Québec-Téléphone also provided forecast expenditure data comparing projects for the years 1995 and 1996 in the current capital plan. The investments in the Basic Telephone Service and Modernization categories are $13.4 million higher in 1996, primarily because the access network modernization program for GTD-5 digital switches uses interface equipment that will not be available until 1996.
The Commission considers the company's explanations of year-over-year expenditure variances for the first two years of the capital plan satisfactory.
B. Economic Justification for Major Programs
The Commission requested that the company outline the reasons, and provide any economic evaluations conducted, for each new major program in the 1995-1999 capital plan. Québec-Téléphone identified and provided detailed information for various major projects, but noted that it has not, as yet, conducted supporting economic evaluation studies.
Based on the evidence provided, the Commission is of the opinion that the planned expenditures for these projects are reasonable, since they relate to enhanced switching technology platforms to meet increased demand and because they provide the capability for new service offerings, improved data transmission service, serving new urban developments, relieving congestion in existing urban sectors and improving network survivability.
The Commission notes that it generally requires companies under its jurisdiction to provide the results of economic evaluations to justify expenditures for economically discretionary modernization or service/network improvement and to verify that the most cost-effective alternative has been chosen for demand-driven expenditures. Although economic evaluations were not provided for the program expenditures noted above, it appears that Québec-Téléphone intends to conduct such evaluations for major programs before expenditures are incurred.
For future capital plan submissions, the Commission's requirements are as follows:
(1) for expenditures to meet growth, the Commission generally expects the most cost-effective technology to be chosen (although no details need to be filed unless specifically requested) and a declining trend in cost/demand ratios (the Commission may ask for present worth of annual cost studies for large or exceptional projects);
(2) for expenditures associated with the development of enhanced technology platforms intended to enable the provision of new services, or with the implementation of measures intended to improve the company's efficiency, the Commission generally expects major program expenditures to be justified by cost-benefit analysis demonstrating a positive net present value (NPV) or anticipated productivity improvements (which may require tracking); and
(3) expenditures for some programs or projects may be justified on a public interest basis (such as extension of service to unserved areas or upgrading of service quality).
C. Future Submissions
The Commission expects the company to file the construction program in the current format on an annual basis.
Future submissions should include the local demand forecast (in terms of incremental annual growth in network access services) and the toll demand forecast (in terms of either annual messages or minutes) for the full forecast period of the capital plan. Data indicating actual local and toll demand should also be provided for each of the two years preceding the forecast period. In addition, the annual submissions should include cost/demand ratios for local and toll growth.
D. Conclusions
Based on the evidence submitted, the Commission finds Québec-Téléphone's 1995-1999 capital plan reasonable.
IV EXTENDED AREA SERVICE
A. General
Québec-Téléphone presented its five-year plan of proposed EAS links. At the regional hearing, the Commission heard from parties seeking EAS between their particular exchanges and nearby exchanges. These interveners represented Murdochville, Sainte-Claire and Saint-Malachie.
The Government of Quebec submitted that the Commission should continue with the more liberal criteria established by the Régie for EAS, and reserve its discretion to make exceptions based on the special needs of subscribers.
In Télébec ltée - Development Plan for 1995-1999 and Revenue Requirement for 1995, Telecom Decision CRTC 94-26, 29 November 1994 (Decision 94-26), the Commission accepted, for the purposes of that Decision, the Community of Interest (COI) levels approved by the Régie of 50% in one direction (calls from one community to another) and 60% overall (between communities). In that Decision, the Commission was also of the view that it was appropriate to conduct a vote when (among other things) the COI criterion is met two months out of twelve. Further, the Commission stated that it would not require that a vote be conducted where the associated individual-line residential (local and EAS supplement) monthly rate increase would be $1.00 or less.
The Commission considers that the EAS regime established for Télébec ltée in Decision 94-26 is also appropriate for the purposes of this Decision with respect to Québec-Téléphone. Therefore, for the reasons outlined in Decision 94-26, the Commission is of the view that, for EAS links to exchanges other than Bell Canada (Bell) exchanges, it is appropriate to conduct a vote when the COI criterion is met two months out of twelve and that a vote be held where the individual-line residential (local and EAS supplement) monthly rate increase would be greater than $1.00.
The Commission approves EAS links proposed for 1995 for which, pursuant to the criteria applicable under the Régie, a vote is not scheduled to take place. In these instances, the Commission does not consider it appropriate to change the applicable requirement on such short notice. All other links proposed for 1995 are approved, subject to the outcome of a vote in those exchanges where the individual-line residential monthly rate increases would be greater than $1.00, with the majority of subscribers responding voting in favour of the new EAS link.
B. Exceptions to EAS Criteria
Mr. Charles Thériault, representing the Chamber of Commerce of the municipality of Sainte-Claire, asked for EAS between Québec-Téléphone exchange 883 (Sainte-Claire) and the Bell exchanges of Québec City and Lévis. Mr. Thériault noted that Sainte-Claire met the distance criterion but failed the 60% COI criterion, although the COI did exceed 50%.
Mr. Daniel Julien representing a group of subscribers from St-Malachie (Le Comité du 642) requested EAS to Québec City and Lévis. Québec-Téléphone noted that the COI was less than 50%.
Mr. François Langlois, M.P., supported both requests, and was of the view that, if subscribers are willing to pay the appropriate rate for EAS, the 60% COI criterion should not apply. He also expressed the view that one-way EAS should be considered if all the criteria for two-way EAS to a Bell exchange are not met, but if Québec-Téléphone's own criteria are met.
Mr. Marc Minville, Mayor of Murdochville, requested EAS between his community and Gaspé. He noted that, although the COI is in excess of 70%, the distance between these two communities is 76 kilometres, which is greater than the applicable criterion of approximately 64 kilometres. The Mayor was of the view that an exception should be made to the criterion because free calling is needed to alleviate the isolation of the community and to encourage development.
Québec-Téléphone replied that it would abide by the Commission's decision regarding exceptions to the criteria, but that, if exceptions are made in these cases, the company should not be obliged to provide one-way EAS, but only two-way EAS.
In Bell Canada - Revised Criteria for Extended Area Service, Telecom Decision CRTC 88-15, 29 September 1988, the Commission noted that, while the creation of a new EAS link generally results in an increase in local rates for the smaller exchange in an exchange pair, such rate increases only partially recover the associated costs. Therefore, further extension of EAS can entail rate increases for other subscribers. The Commission stated that, in order to protect the interests of the general body of subscribers whose local rates might ultimately be affected, a very substantial social and commercial dependency between subscribers should be demonstrated in order for two exchanges to qualify for EAS. The Commission indicated that it is the COI criterion that provides the measure of the social and commercial ties between subscribers in two exchanges. Thus, the COI between EAS exchanges is the key indicator of whether that additional cost burden is in fact justified.
In Bell Canada - Neighbourhood Calling Plan, Telecom Decision CRTC 92-22, 9 December 1992, the Commission stated that, while it would be prepared to consider departures from the EAS criteria for the creation of toll-free calling areas, it was of the view that the incremental costs of any such departures should be borne primarily by subscribers within the affected regions. Furthermore, subscribers faced with a local rate increase should have the opportunity, through some form of vote, to express their views on the proposal in question.
Accordingly, with respect to Sainte-Claire and Saint-Malachie, the Commission directs that the company file for each community a report showing the COI based on the best two months out of twelve, with an estimate as to when these communities will reach the required COI level. As well, each report is to include a ten-year NPV study illustrating incremental costs, lost toll revenues and any payments required to Bell, less the increases in local rates and EAS supplements associated with the introduction of the proposed links. The company is also to provide payment options designed to recover these net costs for establishing these links, to apply if the COI requirements are not met.
With respect to Murdochville, the Commission directs the company to file a similar ten-year NPV study and payment options designed to recover the net costs for the introduction of a Murdochville/Gaspé EAS link.
These reports are to be filed within 90 days. Based on the studies and the options presented, the Commission will consider whether it would be reasonable for the company to establish these EAS links and whether a vote is warranted.
V REGULATORY ADJUSTMENTS AND ACCOUNTING MATTERS
A. Determination of Working Capital
The Régie regulated Québec-Téléphone using a net asset rate base methodology. Under this methodology, only the assets used to provide monopoly services are included in the average net assets in service. However, an allowance for working capital is added to net assets in service in order to determine the average regulated rate base.
Québec-Téléphone calculated its average working capital allowance for 1995 based on 45 days of its cash operating expenses. In addition, Québec-Téléphone proposed to use a 360-day year as the denominator in this calculation, noting that there are exactly eight periods of 45 days in the proposed 360-day year.
The Commission notes that a working capital allowance is normally supported by a lead-lag study measuring the average number of days between the date that expenses are incurred and the date that revenues are recovered by the company. In response to a Commission interrogatory, Québec-Téléphone indicated it had not performed a lead-lag study to support its allowance of 45 days. Rather, it estimated 45 days as the average lag used in the telecommunications industry.
The Commission is of the view that Québec-Téléphone has not provided sufficient justification to support using 45 days in calculating its working capital allowance. Further, the Commission has concerns that 45 days may not be appropriate for the company, since its subscribers are billed for monthly services in advance. Consequently, there may be a lead, and not a lag, between the company's provision of services and its receipt of payment for them.
Having noted its concerns, the Commission is prepared to accept the method used by the company in this proceeding to calculate its allowance for working capital. However, if Québec-Téléphone continues to be regulated using a net asset rate base under the method employed in this Decision, it should provide a lead-lag study to support any working capital allowance to be used to determine its regulated rate base in future revenue requirement proceedings.
B. Les Annuaires du Québec Enr. - Integrality
Les Annuaires du Québec Enr. (LAQ) is a geographic division of Dominion Directory Company (Dominion Directory). Dominion Directory is an operating division of Anglo-Canadian Telephone Company, which in turn is the majority shareholder of Québec-Téléphone.
Québec-Téléphone publishes and produces its own telephone directories. However, it has a long-term contractual agreement with LAQ to market the directories, sell and lay out the advertising space, and represent Québec-Téléphone at Canadian and North American yellow page associations.
In an interrogatory, the Commission asked the company to explain why the earnings of LAQ relating to the services provided to Québec-Téléphone should not be treated as if they were the earnings of Québec-Téléphone. In its response, upon reviewing BC TEL - Revenue Requirements for 1993 and 1994, Telecom Decision CRTC 94-1, 25 January 1994 (Decision 94-1), the company agreed that its corporate relationship with LAQ is similar to the corporate relationship between BC TEL and Dominion Directory.
In Decision 94-1, the Commission concluded that the activities performed by Dominion Directory were integral to BC TEL's provision of basic telecommunication services. In the Commission's view, the reasons set out in Decision 94-1 for this conclusion also apply to Québec-Téléphone, i.e., the directory operations could not exist independent of Québec-Téléphone, as they require the telephone database. The Commission also considers that the provision of directories forms an essential part of, and significantly enhances the value of, Québec-Téléphone's basic telephone service. Accordingly, the Commission concludes that the activities performed by LAQ for Québec-Téléphone are integral to Québec-Téléphone's provision of basic telecommunications services. Further, the Commission considers that, in order to ensure that Québec-Téléphone's rates for telecommunications services are just and reasonable, it is necessary to treat the earnings of LAQ from the activities in question as if they were the earnings of Québec-Téléphone.
In light of the above, pursuant to section 33 of the Telecommunications Act, the Commission has included the earnings of LAQ from the activities noted above in the determination of Québec-Téléphone's revenue requirement. The method and the adjustment applied by the Commission to implement this decision are described below.
C. Les Annuaires du Québec Enr. - Regulatory Adjustment
In response to a Commission interrogatory, Québec-Téléphone proposed to reduce its revenue requirement by $661,000 to reflect LAQ's activities. This proposed adjustment reflects a return associated with a deemed investment in LAQ.
The Commission agrees in principle with the approach proposed by Québec-Téléphone and considers it appropriate to adjust LAQ's earnings to reflect a deemed investment by Québec-Téléphone. However, the Commission disagrees with the mechanics of the calculation proposed by Québec-Téléphone. In particular, the Commission notes that a large portion of LAQ's assets related to Québec-Téléphone's operations are current assets. In addition, an equity rate higher than the midpoint of the approved ROE range is appropriate, due to the additional risk associated with directory as opposed to utility operations. Further, the Commission is not persuaded that awarding a return on a deemed investment base calculated, in part, on market value is appropriate. The Commission's usual practice is to determine the revenue requirement on the basis of historical cost (net book value). Accordingly, the Commission finds that:
(1) the deemed investment in LAQ should be considered to be funded primarily on the basis of short-term debt, rather than on the basis of the combination of short-term debt, long-term debt and equity implied by Québec-Téléphone's capital structure;
(2) the equity portion of the return on the deemed investment should be calculated using the top, rather than the midpoint, of the company's approved ROE range; and
(3) the deemed investment in LAQ should be determined on the basis of book value, rather than market value.
On this basis, the Commission calculates the adjustment to the company's revenue requirement to reflect the activities performed by LAQ to be $952,000.
D. Investment in Alouette Telecommunications Inc.
On 24 March 1992, the Government of Canada announced its decision to sell its 53% share of Telesat Canada to Alouette Telecommunications Inc. (ATI). Québec-Téléphone has an investment in ATI valued at $5,221,000.
Québec-Téléphone stated that it decided to invest in ATI in order to assure itself an association with a company that could provide a viable alternative to fibre optics. Québec-Téléphone considers this alternative important since 40% of its customers are located in remote regions of Quebec where an investment in fibre is not economically justified. In addition, the company maintained that a strategic investment with other Stentor members in ATI is important and will allow it to assure its customers quality of service at competitive prices. Although Québec-Téléphone agreed that its investment in ATI could be viewed as generating investment income, it noted that, just as an investment in a new switching technology must be paid for by current customers, an investment designed to assure future quality and diversity of service must also be borne by current customers.
The Commission notes Québec-Téléphone's submission that it invested in ATI to associate itself with a company that provides an alternative to fibre optics. However, the Commission is not persuaded that, under a net asset rate base method of regulation, this is sufficient justification to meet the test of "used and useful" in providing basic telephone service. The Commission considers this to be a strategic investment on the part of the company, and not an investment in assets in service.
In light of the above, the Commission concludes that Québec-Téléphone's investment in ATI should not be included in its rate base, and has reduced the company's revenue requirement by $749,000 to reflect its exclusion.
E. Accounting Reserve Balance
In decision R.T. 88-015-A, 29 July 1988, the Régie authorized establishing an accounting reserve, wherein Québec-Téléphone accumulated any revenues it earned in excess of its authorized ROE range. The reserve allowed Québec-Téléphone to proceed with toll rate reductions by drawing down the balance in the reserve.
The current balance in the accounting reserve is $1,662,000. Québec-Téléphone is seeking approval to draw down this balance in 1995 in order to partially fund its proposed "envelope" of long distance rate reductions.
The Government of Quebec supported using the balance in the accounting reserve to reduce the additional revenues required by the company. In this regard, the Government of Quebec noted that Québec-Téléphone proposed reducing the level of long distance discounts available during off-peak hours as one of the measures to generate the additional revenue required by the company. The Government of Quebec viewed this proposal as increasing some long distance rates, when the trend in the industry is the opposite. Consequently, it requested that the Commission re-examine this particular rate proposal in the event that the company is allowed to use the balance of the accounting reserve to reduce the amount of the additional funds it needs.
For the reasons discussed in Part X, Section C, below, the Commission is not approving the proposed reductions to long distance discounts during off-peak hours.
The Commission agrees with the approach taken by the Régie in establishing the accounting reserve. The Commission considers the company's proposal to use the balance of its accounting reserve to partially fund its envelope of long distance rate reductions to be consistent with the purpose for which it was intended. Accordingly, the Commission approves Québec-Téléphone using the remaining balance in the accounting reserve (i.e., $1,662,000) to partially fund the long distance rate reductions of $3,447,000 approved in Part X, Section A, of this Decision.
However, if Québec-Téléphone does not proceed with the full $3,447,000 in forecast toll rate reductions in 1995, the amount actually drawn down from the accounting reserve should reflect this. Accordingly, the company is authorized to only draw down from the accounting reserve in 1995 the actual amount of toll rate reductions not funded through other rate changes approved for 1995, which (as discussed in Part X) amount to $1,785,000.
VI OPERATING EXPENSES
A. Adjustment of 1995 Forecast as per Year-to-Date Update of 1994 View
Based on the June 1994 Revision, Québec-Téléphone's 1994 and 1995 Operating Expense forecasts, excluding Depreciation and Taxes, are $105.2 million and $107.7 million, respectively.
In response to a Commission interrogatory, Québec-Téléphone reduced its 1994 expense forecast by $1.2 million to reflect expense reductions in the first nine months of that year. Québec-Téléphone did not revise its 1995 expense forecast.
The Commission is of the view that Québec-Téléphone's 1995 expense forecast should be adjusted downward by $1.2 million in order to maintain the same year-over-year increase in expenses as that forecast in the June 1994 Revision. Accordingly, the Commission has reduced Québec-Téléphone's 1995 Operating Expense forecast by $1.2 million.
B. Stentor Expenses
In response to a Commission interrogatory, the company stated that its 1993 Stentor expenses were $214,683, and that these expenses are forecast to increase to $1.2 million and $1.45 million in 1994 and 1995, respectively. The data submitted by the company indicates that the increase in forecast expenses is primarily due to the company's membership in Stentor Resource Centre Inc.
In an interrogatory, the Commission asked Québec-Téléphone to quantify the actual and expected benefits of its Stentor membership and to provide a list of offsetting expenses, in order to demonstrate the net benefit derived from its membership. Québec-Téléphone responded that, without the membership, the company would have had to develop its own infrastructure at a cost beyond proportion; therefore, the savings from the membership are substantial and favourable, although quite difficult to identify and to evaluate in quantitative terms.
The Commission finds Québec-Téléphone's responses regarding the net benefit from its Stentor membership inadequate. Although Québec-Téléphone claims substantial benefits from its Stentor membership, the company has not identified or quantified the effect of these benefits on its books, and has not provided sufficient evidence to support the forecast level of Stentor expenses for 1995. Accordingly, the Commission has reduced Québec-Téléphone's 1995 Operating Expense forecast by $0.7 million, an amount equivalent to approximately one-half of the company's forecast of 1995 Stentor expenses.
C. Productivity and Forecasting Accuracy
In response to a Commission interrogatory, Québec-Téléphone provided the information necessary to calculate the company's Total Implied Productivity (TIP) index for the years 1989 to 1995. Based on the most recent update of the 1994 expense forecast, which includes nine months of actual expenses, the Commission estimates Québec-Téléphone's forecast TIP at 6.7% and 0.03% for 1994 and 1995, respectively.
Québec-Téléphone did not comment on its productivity, as measured by the TIP index. However, in the June 1994 Revision, Québec-Téléphone provided a list of company performance indicators in support of its conclusion that its performance was considerably better in 1993 than in 1988. Québec-Téléphone also added that the trend of improved performance will continue during the period 1994 to 1999, and that its index of Operating Expenses (excluding Depreciation) per access line should decrease by approximately 1% per year during that period. Furthermore, Québec-Téléphone stated that it plans to undertake some restructuring of its business, so as to improve its performance measures, reduce its costs, improve the quality of service, and maintain a growth of expenses below that of revenues.
The Commission is of the view that the TIP index is an appropriate measure of overall productivity for Québec-Téléphone, and that it is reasonable to assess Québec-Téléphone's 1995 expense forecast based on the corresponding TIP index. The Commission notes that Québec-Téléphone's conclusion of improved company performance is supported by the trend in the TIP index values, up to the year 1994.
However, the Commission considers the 0.03% TIP for 1995 to be contrary to Québec-Téléphone's claim of maintaining its past trend of performance improvement. The Commission estimates that, when the 1995 TIP is re-evaluated to take into account the reductions of $1.2 million and $0.7 million in the company's 1995 Operating Expense forecast, as discussed above in Sections A and B, the resulting TIP increases to 1.8% only. The Commission is of the view that this level of productivity is inadequate, as it does not demonstrate the trend of improved performance forecast by the company. In addition, productivity at this level does not address the Commission's concern that productivity levels not deteriorate, as compared to previous years. The Commission estimates that, if an additional $1.6 million were to be disallowed from the company's 1995 Operating Expense forecast, the TIP index would increase to 3.4%. The Commission notes that, although 3.4% is low in relation to the 1994 forecast TIP of 6.7%, it is approximately equal to the average TIP value for the period 1989 to 1994.
In addition, the Commission notes that an additional $1.6 million disallowance will lead to a total reduction in Québec-Téléphone's 1995 Operating Expense forecast of $3.5 million. The Commission estimates that, without this total reduction of $3.5 million, the company's index of Operating Expenses (excluding Depreciation) per access line will increase in 1995, indicating a deterioration in company performance and a violation of the company's own objective, as discussed above.
The Commission also notes that, based on company-provided data, Québec-Téléphone has underspent the expense forecasts approved by the Régie during the period 1991 to 1994 by amounts ranging between $1.5 million and $5.1 million. The Commission is of the view that the $3.5 million total reduction of Québec-Téléphone's 1995 Operating Expense forecast falls within the range of underspending that the company has realized during that period.
In light of the above, the Commission has reduced Québec-Téléphone's 1995 Operating Expense forecast by an additional $1.6 million.
D. Depreciation
Québec-Téléphone forecast its 1995 depreciation expense at $44 million (excluding amortization expense of $7 million for application software). In 1995, the company intends to implement the depreciation rates from nine new depreciation studies. The new studies are expected to reduce the 1995 depreciation expense by $930,000, which is reflected in the 1995 estimate of $44 million. Based on the information provided by Québec-Téléphone, the Commission finds the company's 1995 depreciation expense estimate reasonable.
E. Conclusions
As detailed above, the Commission finds it appropriate to reduce Québec-Téléphone's 1995 Operating Expense forecast filed in the June 1994 Revision by the amounts summarized below:
($ Millions)
Adjustment of 1995 Forecast 1.2
Stentor 0.7
Productivity 1.6
Total 3.5
After adjustment for the disallowances set out above, Québec-Téléphone's Total Operating Expenses, excluding Depreciation and Taxes, are forecast to be $104.2 million, an increase of 0.14% over the 1994 forecast, which includes nine months of actual expenses.
VII OPERATING REVENUES
In the June 1994 Revision, Québec-Téléphone estimated that Total Operating Revenues would be $217.1 million in 1994 at existing rates and $225.9 million in 1995 at proposed rates. The company did not provide a forecast of 1995 Total Operating Revenues at existing rates in its Development Plan, but did indicate in response to a Commission interrogatory that such revenues would be $220.4 million, an increase of 1.5% over 1994.
Excluding the impact of the accounting reserve and the use of future tax liability, the company estimated Total Operating Revenues at existing rates to be $212.4 million in 1994 and $219.0 million in 1995 (an increase of 3.1% over 1994).
The Commission finds Québec-Téléphone's estimate of 1995 Total Operating Revenues at existing rates to be reasonable.
VIII RATE OF RETURN ON AVERAGE COMMON EQUITY
In decision R.T. 93-055-C, 23 December 1993, the Régie set the 1994 ROE range for Québec-Téléphone's regulated activities at 11.25% to 12.25%, with rates set to achieve an ROE of 11.8%. In setting this range, the Régie utilized a forecast of 7.65% for the average long-term Government of Canada bond (LTC) yield for 1994, made by la Caisse de dépôt et placement du Québec in June 1993. September 1993 forecasts by the Conference Board of Canada confirmed the reasonableness of this rate.
To this LTC rate, the Régie added an overall risk premium of 4.15%, which was made up of two components. The first component was the basic risk premium, which the Régie determined to be 3.81%. The Régie determined the second component of the overall risk premium to be 0.34%, after taking into account the fact that the company was rated lower than other Canadian telephone companies by bond rating agencies.
In this proceeding, Québec-Téléphone requested an ROE range for its regulated activities of 11.25% to 12.25% for 1995, with rates to be set at the midpoint of 11.8% (i.e., the same range as that set by the Régie for 1994). In making this request, the company was of the view that the requested ROE range was reasonable in light of recent Commission determinations for other telephone companies. In particular, the company noted that the average ROE range for a group of seven telephone companies regulated by the Commission is currently about 11.4% to 12.4%.
The Commission notes that the company did not file detailed evidence in support of its requested range. Further, the company provided no discussion as to how recent events would, in its view, affect the level of the company's business risk. In particular, given the timing of the release of Decision 94-19, the company did not comment on the possible impact of that Decision on its business risk. Also, the company did not provide detailed evidence as to what would be a reasonable forecast of LTC rates in 1995. However, the Commission notes that the company did make reference to its LTC assumptions for 1995, stating that LTC rates are estimated to be 7.3% according to the 1994 estimates issued at the end of December 1993.
The Commission notes that the Régie determined the company's overall risk premium to be 4.15% in the context of setting an appropriate ROE range for the company for 1994. For 1995, the company provided no evidence in support of a change to this overall risk premium that might be considered appropriate given recent developments in the telecommunications industry. Rather, the company has asked that its current ROE range be left in place for 1995, in view of recent ROE awards by the Commission.
The Commission is of the view that the company's estimated LTC rate for 1995 is somewhat conservative in light of recent LTC forecasts. Specifically, recent LTC forecasts call for rates to be somewhat higher in 1995 than the rate used by the Régie in determining the company's ROE range for 1994. However, while a detailed analysis would take into account the fact that LTC rates are currently expected to be higher than anticipated when the Régie made its overall ROE determination for 1994, it would also take into account the tendency of risk premiums to decrease as interest rates rise, and vice versa. Absent detailed evidence supporting changes in the company's overall risk premium, the Commission is of the view that any alteration to the company's current ROE range for the factors noted above would be subjective at best.
With respect to financial risk, the Commission notes that the projected common equity ratio for Québec-Téléphone in 1995 is about 53%, which compares to the level for the majority of the telephone companies regulated by the Commission, namely, about 55%. The Commission notes that the company is forecasting essentially no change in its capital structure for 1995 as compared to 1994, and is of the view that no adjustment to the company's ROE range for 1995 should be made for this factor.
In light of all these factors, and considering its recent decisions for other telecommunications carriers, the Commission is of the view that the requested ROE range is reasonable and approves this range for 1995. The Commission has used the midpoint of the approved range of 11.25% to 12.25%, that is 11.8%, to determine Québec-Téléphone's revenue requirement for 1995 and to set rates for its regulated activities.
As described earlier in this Decision, the Régie established an accounting reserve for Québec-Téléphone, to which the company was to credit any earnings in excess of its allowed range. The Régie also stated that the company would require the Régie's approval in order to use funds in the reserve.
As stated earlier, the Commission agrees with the approach taken by the Régie in establishing the accounting reserve. Accordingly, in 1994, Québec-Téléphone is to credit the reserve with any earnings in excess of the range approved by the Régie for that year. If Québec-Téléphone earns over the top of its allowed ROE range for its monopoly rate base in 1995, the company is directed to credit the excess earnings to the accounting reserve. The company will require the Commission's approval in order to use the funds in the reserve.
IX METHOD OF REGULATION AND REVENUE REQUIREMENT
A. Method of Regulation
As noted earlier, the Régie regulated the rate of return of Québec-Téléphone's monopoly operations only. Operations not subject to earnings regulation include inside wiring, cellular and other mobile services, voice messaging, and the sale and rental of terminal equipment.
The Commission's past practice has generally been to determine the revenue requirement of the telephone company as a whole. However, in Decision 94-19, the Commission determined that the rate bases of the Stentor members subject to the Decision would be split into Competitive and Utility segments, effective 1 January 1995. In addition, the Commission established a three-year transition regime, from 1 January 1995 to 31 December 1997, whereby it will move towards the implementation of price cap regulation for the Utility segment. During the transition period, services in the Utility segment (essentially, local and access services) will remain in the rate base and be subject to earnings regulation. Services in the Competitive segment will no longer be subject to earnings regulation.
The Commission intends to issue a public notice, initiating a proceeding to consider the appropriate approach (or approaches) for the regulation of the various independent telephone companies now under its jurisdiction. In general, the Commission considers that any changes to the present method of regulation for Québec-Téléphone would not likely take effect before 1996.
B. Revenue Requirement
Québec-Téléphone estimated that the total revenue required to allow it to earn the midpoint of its ROE range (11.8%) in 1995 was $227.5 million (Operating Revenue of $225.9 million and Other Revenue of $1.6 million). Further, the company estimated that its revenues for 1995, at existing rates, would be $220.6 million. The difference between these two amounts, i.e., $6.9 million, was referred to by the company as its "manque à gagner" (shortfall). After taking into account its proposed provision for 1995 long distance rate reductions, the impact of certain 1994 tariff filings not included in its 1994-1998 five-year plan, and a transfer of all remaining funds from its accounting reserve, the company estimated that it would require an increase in total revenues of $9.0 million in 1995 in order to earn its midpoint of 11.8%.
The Commission estimates that the revenue increase required in 1995 to allow Québec-Téléphone to earn the midpoint of its allowed ROE range on its regulated sector is $3.7 million.
In determining this amount, the Commission first estimated that the company's shortfall would be $1.5 million, or $5.4 million lower than the shortfall estimated by the company. The Commission's estimate takes into account (1) the Commission's downward adjustment to the company's Operating Expense forecast ($3.5 million), (2) a downward adjustment to the company's working capital allowance as a result of this expense disallowance (with a resulting downward adjustment to the company's rate base), (3) a further reduction in the company's rate base to reflect the Commission's decision that Québec-Téléphone's investment in ATI should not be included in the rate base, and (4) the Commission's decision regarding the appropriate regulatory treatment of the earnings generated by LAQ.
The Commission then took into account the impact of certain 1994 local and long distance rate filings, the company's proposed long distance rate reductions for 1995, and its decision that the current balance in the accounting reserve be used to fund, in part, the company's proposed long distance rate reductions. As noted above, after taking these factors into account, the Commission estimates that the revenue increase required in 1995 to allow Québec-Téléphone to earn the midpoint of its allowed ROE range on its regulated sector is $3.7 million. The Commission estimates that the additional revenues will be generated as follows: (1) approved local rate increases totalling about $3.4 million (compared with the $6.9 million proposed by Québec-Téléphone), (2) $140,000 from optional services, and (3) $219,000 from the company's proposal to increase local circuit rates and to restructure such rates.
C. Interim Rates and the Effective Date of New Rates
In its application, Québec-Téléphone contemplated that the Commission's decision would be released in early December 1994, thus enabling it to reduce, but not avoid (due to its billing system, which has 10 cycles), billing adjustments that would be required on the first customer bills of the new year.
On 11 October 1994, the Commission addressed interrogatories to the company as to its preferred effective date for final rates, in the event a decision would not be issued prior to 1 January 1995. Specifically, the company was asked whether:
(1) it would propose that final rates be made effective 1 January 1995, which would require customer billing adjustments; or
(2) it would prefer final rates effective 1 February 1995, with any approved revenue increase to be recovered through rates over 11 months rather than 12 months.
In addition, the company was asked whether it would favour making existing rates interim effective 1 January 1995.
Québec-Téléphone replied that, in the event the Commission could not issue a final decision by 2 December 1994, it would favour a decision issued at the end of January 1995 with an effective date of 1 January 1995 for rate revisions.
The Commission considers an effective date of 1 January 1995 appropriate. By letter dated 14 December 1994, the Commission made all of the company's existing rates interim effective 1 January 1995. The Commission notes that, in view of the company's billing system, it would appear that some customer billing adjustments would have been necessary even if new rates had been made effective 1 February 1995.
X TARIFF REVISIONS
A. Provision for Toll Rate Reductions
Québec-Téléphone proposed to reduce its long distance rates in 1995 in order to maintain such rates at levels comparable to those of neighbouring telephone companies, particularly Bell. The company proposed to create a provision of $3,447,000 as an "envelope" of funds available to offset revenue losses from toll rate reductions. Due to the evolving competitive nature of the toll services market, the company was not able to foresee the particular toll rate changes it would make during 1995. The company did, however, undertake to implement a toll rate reduction that would benefit residential and business customers who may not necessarily have large monthly toll bills. The company is currently operating a market trial for such a service, called "Distinction", which provides a 20% toll discount and the opportunity to accumulate points towards further discounts. The service entails a $2 per month subscription fee.
The Commission is of the view that Québec-Téléphone's objective of maintaining its toll rates at a level comparable to those of other telephone companies is desirable, and that attaining this objective will require the company to make toll rate reductions in the coming year. The Commission also notes that the company's provision for toll rate reductions, offset to some extent by local rate increases, is not inconsistent with initiatives by other telephone companies to move rates towards the costs of providing service.
The Commission approves the provision of $3,447,000 for toll rate reductions in 1995, with $1,662,000 of that amount to be provided from the current balance of the accounting reserve. The remaining amount of $1,785,000 will be generated through other rate changes.
The Commission notes that the company requires approval for any changes to toll rates, and that this will include changes funded by the provision for toll rate reductions. Further, to the extent that the full $3,447,000 of reductions are not implemented in 1995, an amount is to be left in the reserve to reflect any unutilized amount (see Part V, Section E).
B. Provision for Additional Revenues from Optional Services
Québec-Téléphone proposed to include in the determination of its revenue requirement a provision of $140,000 to be generated from the introduction of new optional services, service rate changes during 1995, and stimulation of demand for existing services. The company stated that, since it has recently restructured its Call Management Services and introduced a universal voice mail service, the primary revenue source in 1995 will be the stimulation of demand for these services. The Commission accepts the company's estimate of $140,000 of additional revenue to be generated from optional services in 1995.
C. Reduction to Off-Peak Discounts for Basic Toll Rates
Québec-Téléphone proposed to reduce evening toll discounts from 35% to 30% and to reduce the Saturday, Sunday and late-night toll discounts from 60% to 50%. The proposed rate changes were estimated to generate $1,732,000 in 1995, which the company argued would provide additional revenue to offset the need for local rate increases.
The Commission is of the view that the proposed reduction to off-peak toll rate discounts represents an increase to basic toll rates that largely affects residential subscribers. The Commission notes that this increase is proposed concurrently with a provision for toll rate reductions that are not likely to provide residential subscribers with a benefit comparable to that provided by the current off-peak discounts. Further, the proposed rate change does not contribute to the objectives of rate restructuring which are the basis of other rate changes approved in this Decision. The proposed changes to off-peak toll discounts are therefore denied.
D. Restructuring of Rates for Local Circuits
Québec-Téléphone proposed to increase local circuit rates and to restructure rates to introduce flat rates not related to distance. Québec-Téléphone estimated the 1995 revenue impact of these proposed rate increases to be $219,000.
The Commission approves the restructuring of local circuit rates and the proposed rate increases.
E. Local Rate Restructuring and Local Rate Increases
Québec-Téléphone proposed to restructure its local rates by reducing the number of rate groups from four to two. For both residence and business customers, the proposed restructuring would result in (1) current rate group 1 moving to rate group 2 rates, and (2) current rate group 3 moving to rate group 4 rates. In addition to the rate group compression, the company proposed to increase rates for basic service and regional service supplements. Québéc-Téléphone estimated that, in total, the rate restructuring and rate increases would generate additional revenues in 1995 of $5.7 million from local rates and $1.2 million from regional service supplements. This represents an average increase in local rates of 11.2% and an average increase of 11.6% in regional supplement rates.
The company presented statistics indicating that the price of telephone service in constant 1988 dollars, including toll service, has decreased by 3% over the period 1988 to 1995. Further, during this period, the penetration of telephone service in its territory has increased and service improvements have been implemented. The company concluded that basic telephone service would remain affordable, even after the proposed rate increases.
The Commission received comments from subscribers and from interveners appearing at the Commission's regional hearing opposing the proposed local rate increases.
The Commission, after considering the positions of all parties to this proceeding, is of the view that the rate group compression proposed by Québec-Téléphone is reasonable. It will reduce the rate differential among rate groups and will bring rates for local service closer to costs. However, the Commission notes that, unlike the proposed local rate restructuring, the regional supplement rate increases do not contribute to a reduction in the rate differential among customers. These rates were also subject to revision during 1994.
With respect to local rate increases, the Commission has made adjustments to the company's revenue and expense forecasts, reducing the revenue to be generated by increases in local rates and regional supplement rates. Rather than the $6.9 million proposed, the Commission finds the revised revenue required to be generated from local and regional rate increases to be approximately $3.4 million. Thus, the local and regional rate increases approved below are lower than those proposed by the company.
The Commission directs that, effective 1 January 1995, Québec-Téléphone implement its residence and business rate restructuring, and that rates be modified as follows:
(1) existing rate group 1 is to move to rate group 2 rates;
(2) existing rate group 3 is to move to rate group 4 rates; and
(3) rate group 2 rates are to increase by 5% and rate group 4 rates are to increase by 3% for residential customers and for business single-line and multi-line customers, as set out in the table below.
In addition, the proposed rates for Centrex service and Datamedia service are approved, effective 1 January 1995, and the proposed rate increase for the regional supplement is denied.
The Commission considers that this local rate restructuring and the moderated local rate increases approved will meet Québec-Téléphone's objectives for rate group compression and reduced rate differentials, and will move rates closer to the costs of providing service.
The approved local rate restructuring and increases represent average increases in local rates of 4.2% for residence customers and 6.0% for business customers, as compared to the 11% increase proposed for both residence and business customers.
Local Services - Monthly Rates
Effective 1 January 1995
Actual   Approved  Increase (%)
Rate     Rate
Single Line Basic Service
Residence Service
Tariff Group 1 10.95 11.85 8.2
Tariff Group 2 11.30 11.85 4.9
Tariff Group 3 11.75 12.30 4.7
Tariff Group 4 11.95 12.30 2.9
Business Service
Tariff Group 1 26.40 31.20 18.2
Tariff Group 2 29.70 31.20 5.1
Tariff Group 3 33.15 35.65 7.5
Tariff Group 4 34.60 35.65 3.0
Multi-Line Basic Service
Business Service
Tariff Group 1 46.00 55.00 19.6
Tariff Group 2 52.40 55.00 5.0
Tariff Group 3 58.90 61.85 5.0
Tariff Group 4 60.05 61.85 3.0
F. Other Issues Raised by Interveners
Two interveners at the regional hearing objected to Québec-Téléphone's deletion from its tariff, earlier in 1994, of the provision for the temporary suspension of service (for example, to provide seasonal suspension of service). The Commission notes that, pursuant to this suspension service, the company would charge one-half of the basic service rate during the period of suspension. The company argued that this rate did not cover the administrative and operating costs of providing the service. The Commission reaffirms its earlier decision to delete temporary suspension of service from the company's tariff, and notes that there are alternative arrangements that can be made with the company to provide for a temporary suspension of service, albeit at a higher cost.
Three interveners at the regional hearing requested that no local rate increase be approved, or that the increase be kept to a minimum. The Commission has taken these concerns into account by moderating the local rate increases in relation to those proposed by the company, by denying an increase to regional supplement rates, and by denying the proposed reduction to off-peak discounts for basic toll service.
G. Filing of Tariff Pages
Québec-Téléphone is directed to issue, by 9 February 1995, revised tariff pages giving effect to the tariff revisions approved in this Decision, effective 1 January 1995.
Allan J. Darling
Secretary General
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