ARCHIVED -  Telecom Public Notice CRTC 96-8

Telecom Public Notice

Ottawa, 12 March 1996

Telecom Public Notice CRTC 96-8

PRICE CAP REGULATION AND RELATED ISSUES

 I INTRODUCTION

 In Review of Regulatory Framework, Telecom Decision CRTC 94-19, 16 September 1994 (Decision 94-19), the Commission determined that, among other things, earnings regulation would be replaced with price cap regulation for the Utility segment, effective 1 January 1998.

 In Implementation of Regulatory Framework - Splitting of the Rate Base and Related Issues, Telecom Decision CRTC 95-21, 31 October 1995 (Decision 95-21), the Commission stated that, commencing in early 1996, it would hold a proceeding to consider the issues associated with the implementation of a specific price cap regime that would apply to AGT Limited (AGT), BC TEL, Bell Canada (Bell), The Island Telephone Company Limited (Island Tel), Maritime Tel & Tel Limited (MT&T), MTS NetCom Inc. (formerly Manitoba Telephone System), The New Brunswick Telephone Company, Limited (NBTel) and Newfoundland Telephone Company Limited (Newfoundland Tel) (the telephone companies).

 Accordingly, the Commission hereby initiates a proceeding to determine an appropriate form of price cap regulation for the telephone companies' Utility segments to be implemented effective 1 January 1998. The Commission directs the telephone companies to file information and proposals, and invites submissions from interested parties on this matter.

 The Commission encourages the telephone companies, to the extent possible, to address common aspects of their price cap proposals as a single submission through Stentor Resource Centre Inc. (Stentor).

 II ISSUES

 A. General

 In Decision 94-19, the Commission considered that, in general, price regulation allows for more efficient and effective regulation than rate of return regulation. Among other things, the effectiveness of price cap regulation is dependent on establishing the major components of a price cap plan in a manner that fairly balances the interests of subscribers, shareholders and other affected parties over the price cap period and setting the rates of the Utility segment prior to implementation of price caps (going-in rates) at appropriate levels.

 Accordingly, in the proceeding initiated pursuant to this Public Notice, the Commission will set the principles and components of price cap regulation for each telephone company and will issue a decision in 1997 in order to allow the companies sufficient time to implement the approved price cap regime on 1 January 1998. With respect to the going-in rates, as discussed in Section F, the Commission will examine in this proceeding the amount of the third rebalancing component (as stated in Decision 95-21) and other issues, such as accelerated depreciation expense which could have a significant impact on the going-in rates.
 

 The Commission notes that the results of several other proceedings (either currently underway or to be initiated), identified in Section E, will impact on the final determination of the telephone companies' going-in rates. In addition, the telephone companies' financial forecasts for 1997 will likely have to be updated closer to the 1 January 1998 implementation date for price cap regulation. Therefore, in the decision to be issued pursuant to this proceeding, the Commission will set out directions for a follow-up proceeding in 1997 to finalize the going-in rates for each telephone company.

 As discussed in Section B, a price cap plan contains a measure of the company's efficiency gains, or productivity offset, which is a fundamental component of price cap regulation. Given the importance of the productivity offset, the Commission expects that the telephone companies and interested parties proposing productivity offsets would provide, on a timely basis, copies of all productivity studies, including back-up documentation, in order to ensure that the proceeding is not needlessly delayed. Specific details with respect to the productivity offset are set out in Section B.

 In the Sections below, the Commission, by way of guidance, provides a brief description of various issues relating to the following: elements of price cap plans; self-correcting mechanisms; ancillary regulation and reporting requirements; contribution; and depreciation and rate rebalancing.

 B. Elements of Price Cap Plans

 Under price cap regulation, the telephone companies' services that are subject to price caps are grouped into one or more service baskets, each of which is subject to a price cap index. As a general rule, the price cap index is adjusted annually by taking into account the annual change in inflation less the productivity offset and any exogenous factor adjustments. The telephone company may change rates for individual services within the basket as long as the aggregate price for the services in the basket, taken as a whole, complies with the price cap index and any service category banding constraints.

 The following is a more detailed discussion of issues concerning the elements of price cap plans: (1) measure of inflation; (2) productivity offset; (3) exogenous factor adjustments; and (4) service baskets.

 1. Inflation Measure

 In general, most price cap plans include a measure of the rate of inflation to account for changes to the costs faced by the telephone company. The price cap index is adjusted automatically on an annual basis by the rate of inflation. Ideally, the measure of inflation should not only attempt to accurately reflect the changes to the telephone company's costs, but should also be available from an independent source on a timely basis, be easily understood, and not be subject to manipulation.

 There are a number of measures of inflation that are readily available on a national basis and, in some instances, on a regional or industry-specific basis. Among other things, an assessment of the timeliness, practicality and precision of the available inflationary measures will need to be addressed in determining the appropriate measures to be used in the telephone companies' price cap plans.

 2. Productivity Offset

 a. General

 In simple terms, the productivity offset (commonly referred to as the X-factor) in a price cap plan should be a proxy for the efficiency gains that a telephone company would be expected to achieve under competitive market conditions. In general, assuming the productivity offset is set correctly, the telephone company retains the benefits of any efficiency gains achieved in excess of the level set by the X-factor.

 To a certain extent, the X-factor reflects the fact that increases in the telephone company's costs per unit of output have historically been below that of the economy as a whole due to greater productivity gains and lower input price changes. In view of this, the telephone companies are to provide productivity studies that include historical data as well as projections of an X-factor in their proposed price cap plans.

 Given that price cap regulation will apply to the Utility segment only, the Commission considers that productivity studies for the Utility segment would be desirable. However, in view of the fact that the split rate base regime came into effect on 1 January 1995, some of the telephone companies may have limited data to estimate Utility segment productivity. In that event, in order to assess the Utility segment productivity, the telephone companies are to provide estimates of productivity for the entire company in addition to any estimates of the Utility segment productivity.

 In the event that some of the telephone companies are not able to provide any productivity studies, alternative methods of arriving at an X-factor for the Utility segment will need to be examined. For those companies, the Commission will determine whether an X-factor obtained from one telephone company or a group of telephone companies could be applied, as a benchmark, to each or all of the telephone companies that do not have productivity studies.

 With regard to the X-factor, the Commission invites comments on the following issues:

 (i) an industry-wide X-factor that could be incorporated into company-specific X-factors, or alternatively, using company-specific data only to determine the appropriate X-factor for each telephone company;

 (ii) an X-factor that would be recalculated, on an annual basis, as a moving average of several years of estimated productivity offsets;

 (iii) a selection of combined X-factors and earnings sharing mechanisms from which the telephone company would choose the combination that best meets the company's expectations at the outset of the price cap period (e.g., there could be three X-factors, two of which would involve earnings sharing, while the third, set at a challenging level, would not); and

 (iv) freezing the aggregate levels of rates for services in the Utility segment at the start of the first price cap period until more reliable and/or sufficient Utility segment productivity data becomes available (i.e., the X-factor would be set equal to the prevailing annual rate of inflation).

 b. Productivity Studies

 In Competition in the Provision of Public Long Distance Voice Telephone Services and Related Resale and Sharing Issues, Telecom Decision CRTC 92-12, 12 June 1992 (Decision 92-12), the Commission found that productivity growth is more accurately estimated using cost weights, rather than revenue weights, to aggregate outputs. However, in Decision 92-12, the Commission recognized that the required cost weights may not always be available. Thus, the Commission is of the view that, if Total Factor Productivity (TFP) is used to estimate the Utility segment X-factor, the use of revenue-weighted productivity estimates may be necessary.

 The Commission notes that, in addition to TFP, other methods could be used to estimate an X-factor, such as the historical revenue method, historical price method, implied productivity and offsets developed on the basis of informed judgment.

 Interested parties requesting particular studies to be carried out by the telephone companies should describe, in detail, the data sources required for a particular X-factor method. Further, parties should avail themselves of information and data that is readily available in order to avoid unnecessary delays to the examination of the issues in this proceeding.

 3. Exogenous Factors

 Exogenous factors are, in general, occurrences beyond the control of the telephone company that result in changes to the telephone company's revenues and expenses and that are not reflected in the other elements of the price cap plan.

 In Teleglobe - Review of the Regulatory Framework, Telecom Decision CRTC 96-2, 2 February 1996, the Commission defined exogenous factors to be, in general, changes that are triggered by legislative, judicial or administrative actions that are beyond the control of the company, and have a significant impact on the company such that, barring an adjustment to the price regulation plan, unreasonably high or low rates may result. The Commission considers this definition to be appropriate for determining which factors, if any, should be considered for exogenous treatment in the telephone companies' price cap plans.

 With reference to exogenous factors, the Commission invites comments on the following issues:

 (i) the factors that should be considered exogenous in the telephone companies' price cap plans;

 (ii) the conditions under which the factors in (i) above should be considered for inclusion in the price cap index (e.g., only if a change in the exogenous factor results in a significant financial impact on the Utility segment); and

 (iii) the process and the information that would be required for determining whether any such factors, from (i) and (ii) above, would actually be reflected in the determination of the price cap index.

 4. Service Baskets

 In most price cap plans, telephone services are grouped into one or more service baskets, each of which is subject to a price cap index. Most often, services are grouped into baskets based on criteria such as homogeneity and similarity in demand price elasticities. Sometimes, the services within a particular basket are further subdivided into service categories and a constraint, or a service band, is imposed to further limit the magnitude of the company's pricing actions in relation to the price cap index. Price changes that comply with the price cap index and any service band constraints are given expedited disposition.

 With regard to service baskets, the Commission invites comments on the following issues:

 (i) the composition and number of baskets into which the telephone companies' Utility segment services are to be placed, and the criteria to be employed in making that determination;

 (ii) the appropriateness of creating service categories and service bands within the basket(s), including the objectives for setting service bands and the required implementation details;

 (iii) whether it is appropriate to exclude some Utility segment services from price cap regulation and, if so, the service(s) or class(es) of services to be excluded;

 (iv) with the development of competition in the provision of Utility segment services, the specific criteria to be used for determining whether service(s) or class(es) of services in the Utility segment should be transferred to the Competitive segment and the process for reviewing and approving any such transfers;

 (v) in order to measure the telephone company's compliance with the price cap index, the methodology for developing the Actual Price Index and any required Service Band Index; and

 (vi) any procedural modifications to review tariff amendments that comply/do not comply with the price cap index and/or service bands.

 C. Self-Correcting Mechanisms

 The Commission notes that a number of jurisdictions in the United States that have implemented price cap regulation have adopted earnings sharing mechanisms, in part, to provide a measure of protection for consumers and company shareholders against possible errors in setting the productivity offset under those price cap plans.

 The Commission notes that there are other means that can be used to minimize the impact of errors that may occur in setting the initial parameters of the price cap plan or distortions in the initial parameters that may occur due to rapid unforeseen change, including: (1) a moving average to recalculate the productivity offset, on an annual basis, as noted in Section B; and (2) the length of time that the initial price cap plan remains in place prior to any review of the plan.

 The Commission invites comments on the following issues with respect to self-correcting mechanisms, having regard to the desire to have a price cap plan that provides for the benefits of more streamlined regulation, creates incentives for the companies to be more efficient and, at the same time, ensures that rates are just and reasonable:

 (i) whether to adopt any earnings sharing for the Utility segment as a component of the price cap plan and the details of any such plans;

 (ii) the length of time between review periods of the price cap plan and the criteria that should be used to evaluate the success or failure of the price cap plan; and

 (iii) the extent to which the financial performance and viability of the corporation as a whole and/or the Utility segment should be considered in modifying the price cap plan prior to the end of the price cap period.

 D. Ancillary Regulation and Reporting
Requirements

 In this proceeding, the Commission will review the need to maintain or modify the existing ancillary regulation and reporting requirements (such as the Construction Program Review, Phase I accounting directives, and Phase II and Phase III costing) under price cap regulation. In addition, the Commission will determine the reporting requirements for monitoring the effectiveness of price cap regulation.

 As part of their submissions, the telephone companies are directed to provide comments on the continued applicability of their current ancillary regulation and reporting requirements under their price cap proposals and to propose any required modifications with supporting rationale. The telephone companies' submissions should also address how the effectiveness of price cap regulation should be monitored.

 Further, with respect to the Quality of Service, the Commission notes that the need to maintain quality of service standards with respect to essential Utility segment and bottleneck facilities under a price cap regime is being addressed in the proceeding initiated by Review of the Quality of Service Indicators, Telecom Public Notice CRTC 1994-50, 21 October 1994.

 E. Contribution

 In Decision 94-19, the Commission stated its intention to discontinue the annual contribution proceeding and to seek comments on how the contribution component of the Carrier Access Tariff should be treated under a price cap regime. The Commission also stated that the proceeding to implement price cap regulation would provide an opportunity for parties to comment on how any residual contribution requirements should be managed in a price cap environment.

 The Commission considers that, under price cap regulation, any contribution mechanism should be: (1) streamlined, to the extent possible; (2) sustainable during the evolution to a more competitive marketplace; and (3) simple to administer and update on a going-forward basis without the requirement for an annual contribution proceeding.

 The Commission notes that the contribution requirement has historically been calculated using the residual access/local shortfall on an annual basis. To the extent that the third rebalancing amount does not fully recover the access/local shortfall, an issue in this proceeding will be how the remaining shortfall, after the third rebalancing component is taken into account, should be recovered under price cap regulation.

 The access/local shortfall and the associated contribution rate may also be impacted by the Commission's determinations to be made in a number of proceedings (for example, the proceedings initiated by 1996 Contribution Charges, Telecom Public Notice CRTC 95-52, 8 December 1995; the 1997 contribution charges proceeding; Equal Access, Telecom Public Notice CRTC 94-26, 24 May 1994; Implementation of Regulatory Framework - Local Interconnection and Network Component Unbundling, Telecom Public Notice CRTC 95-36, 11 July 1995; and Local Service Pricing Options, Telecom Public Notice CRTC 95-49, 22 November 1995).

 In Decision 94-19, the Commission stated its intention to further review the scope of contribution paying services. To this end, the Commission will be issuing a public notice to initiate a proceeding to deal with the scope of the contribution paying services.

 In this proceeding, the Commission will establish the principles for treating contribution under price cap regulation in order to develop a mechanism for handling contribution flows in the follow-up proceeding. This mechanism will need to be adaptable to the emergence of local competition and be consistent with the objectives for any contribution mechanism, as noted above.

 With reference to contribution, the Commission invites comments on the following issues:

 (i) who should share in absorbing any residual access/local shortfall that exists after the implementation of price cap regulation;

 (ii) whether the existing contribution from toll to local services under price cap regulation should be targeted to particular services, rate elements or customers and, if so, how this should be done;

 (iii) the desirability of capping any contribution requirement at the start of the price cap period, as opposed to recalculating this requirement during the period, and the mechanism for recovering that contribution requirement during the period; and

 (iv) the mechanism for treating changes to contribution under price cap regulation (for example, the feasibility of treating contribution as an exogenous factor in the calculation of the price cap index, or treating contribution as a separate basket within the Utility segment).

 F. Other Issues

 1. Depreciation

 In Decision 95-21, the Commission stated that it was not prepared, in general, to approve increases in depreciation expense related to the Utility segment that arise solely from the telephone companies' investment in broadband facilities. However, the Commission stated that there are circumstances which may arise during the transition to price caps where changes in depreciation life characteristics may be warranted, independent of any broadband initiatives. The Commission further noted that any application to significantly accelerate depreciation expense may be assessed in light of any impact on the going-in rates under price cap regulation.

 With reference to depreciation, the Commission invites comments on the following issues:

 (i) the extent to which the full cost of the investments made in the Utility segment under rate of return regulation should be reflected in the going-in rates and/or in rates under price cap regulation;

 (ii) the magnitude of any over/under accrual resulting from any proposed change in depreciation life characteristics prior to the implementation of price cap regulation;

 (iii) the methods for recovering any depreciation deficiencies resulting from (ii) above, in the going-in rates and/or in rates under price cap regulation; and

 (iv) the applicability and treatment of current Phase I depreciation directives under price cap regulation.

 2. Rate Rebalancing

 In Decision 95-21, the Commission reaffirmed the annual local rate increase of $2 per month approved in Decision 94-19 for each of the years 1996 and 1997. As noted above, the Commission stated that the amount of the third rebalancing component would be considered in the proceeding to implement price caps.

 In addition to the issues set out in Section E, the Commission invites comments on the following rate rebalancing issues:

 (i) the amount of, and the criteria to evaluate the third rebalancing component which would take effect with the introduction of price cap regulation;

 (ii) the extent to which there would be a need for further local rate increases beyond the third rebalancing component and the mechanism for dealing with these under price cap regulation; and

 (iii) whether the telephone companies should be required to apply any revenue increases arising from (i) and (ii) above to reduce long distance rates and, if so, how.

 III PROCEDURE

 1. AGT, BC TEL, Bell, Island Tel, MT&T, MTS NetCom Inc., NBTel and Newfoundland Tel (the telephone companies) are made parties to this proceeding.

 2. Other parties wishing to participate fully in this proceeding (i.e., to be served with copies of various submissions, participate at the hearing, etc.) must notify the Commission of their intention to do so by writing to Mr. Allan J. Darling, Secretary General, CRTC, Ottawa, Ontario, K1A 0N2, fax: 819-953-0795, by 30 April 1996. Parties are to indicate in the notice whether or not they wish to receive disk versions of hard copy filings. The Commission will issue a complete list of parties and their mailing addresses, identifying those parties who wish to receive disk versions.

 3. Any person who wishes merely to file written comments in this proceeding, without receiving copies of the various submissions or appearing at the hearing, may do so by writing to the Commission at the address noted in the previous paragraph by 21 October 1996.

 4. By 15 March 1996, the Commission will address interrogatories to the telephone companies regarding the issues set out in this Public Notice. The telephone companies are directed to file responses to the interrogatories with the Commission and serve copies on all parties by 10 June 1996.

 5. The telephone companies are directed to file with the Commission, serving copies on all parties, their evidence or submissions, including any specific proposals they have regarding the form of price cap regulation that should apply. All such material is to be filed with the Commission and served on all parties by 10 June 1996.

 6. Parties may address interrogatories to the telephone companies. Any such interrogatories must be filed with the Commission and served on the telephone company or telephone companies in question by 5 July 1996.

 7. Responses to interrogatories addressed pursuant to paragraph 6 are to be filed with the Commission and served on all parties by 30 July 1996.

 8. Requests by parties for further responses to their interrogatories, specifying in each case why a further response is both relevant and necessary, and requests for public disclosure of information for which confidentiality has been claimed, setting out the reasons for disclosure, must be filed with the Commission and served on the party or parties in question by 6 August 1996.

 9. Written responses to requests for further responses to interrogatories and for public disclosure must be filed with the Commission and served on the party making the request by 12 August 1996.

 10. The Commission will issue a determination with respect to requests for disclosure and for further responses as soon as possible, and intends to direct that any information to be provided pursuant to that determination be filed with the Commission and served on all parties to the proceeding by 6 September 1996.

 11. Parties other than the telephone companies may, by 23 August 1996, file with the Commission and serve on all other parties evidence or other submissions.

 12. Parties may address interrogatories to any party who files evidence or submissions pursuant to paragraph 11. Any such interrogatories must be filed with the Commission and served on the party or parties in question by 12 September 1996.

 13. Responses to interrogatories addressed pursuant to paragraph 12 are to be filed and served on all parties by 2 October 1996.

 14. Requests by parties for further responses to their interrogatories, specifying in each case why a further response is both relevant and necessary, and requests for public disclosure of information for which confidentiality has been claimed, setting out the reasons for disclosure, must be filed with the Commission and served on the party or parties in question by 9 October 1996.

 15. Written responses to requests for further responses to interrogatories and for public disclosure must be filed with the Commission and served on the party making the request by 15 October 1996.

 16. Where a document is to be filed or served by a specific date, the document must be actually received, not merely mailed, by that date.

 17. In addition to hard copy filings, parties are encouraged to file with the Commission electronic versions of their submissions in accordance with the Commission's Interim Telecom Guidelines for the Handling of Machine-Readable Files, dated 30 November 1995. The Commission's Internet eMail address for electronically filed documents is public.telecom@crtc.x400.gc.ca. Electronically filed documents can be accessed at the Commission's Internet site at http://www.crtc.gc.ca.

 18. An oral public hearing is scheduled to begin at 9:00 a.m. on or around 21 October 1996 in Hull, Quebec. The hearing will last no more than five weeks. The Commission will issue further directions with respect to the oral public hearing.

 Allan J. Darling
 Secretary General

AVI96-8_0