ORDER NO. 97-180

ENTERED MAY 22 1997

This is an electronic copy.

BEFORE THE PUBLIC UTILITY COMMISSION

OF OREGON

UT 135

DISPOSITION: RATE SCHEDULE PERMANENTLY SUSPENDED

On January 3, 1997, U S WEST Communications, Inc., filed a rate schedule that included an Interconnection Cost Adjustment Mechanism (ICAM). At a public meeting on January 28, 1997, the Public Utility Commission of Oregon (Commission) suspended the filing. At a prehearing conference on March 6, 1997, Administrative Law Judge, Thomas G. Barkin, established a briefing schedule on the issue of the legal sufficiency of the ICAM filing.

On March 31, 1997, the following parties filed joint comments: MCI Telecommunications Corporation (MCI), AT&T of the Pacific Northwest, Inc., (AT&T), TCG Oregon (TCG), MFS Intelenet of Oregon, Inc., (MFS), Electric Lightwave, Inc., (ELI), Enhanced Telemanagement dba Frontier Telemanagement (Frontier). These parties are referred to as Joint Parties. In addition, Sprint Communications Company L.P., (Sprint) and the Commission Staff filed briefs independently. USWC filed a reply brief on April 18, 1997. At the request of the Joint Parties, the ALJ allowed further briefing. MFS filed a brief on May 12, 1997. USWC filed a response to MFS on May 16, 1997.

ICAM Proposal

USWC is proposing the ICAM to recover start-up costs that it claims it will incur to implement the mandates of the Telecommunications Act of 1996 (Act). USWC claims the costs included in the ICAM are not recovered through any other mechanism already authorized under the Act or in Commission approved tariffs. In essence, the ICAM is a surcharge on rates paid by telecommunications carriers for interconnection, unbundled network elements, and resale to pay for unanticipated past and future expenditures associated with rearranging USWC's network to accommodate the mandates of the Act.

The ICAM is designed to recover past, present and future costs incurred for the following purposes:

Financing or paying for unplanned network upgrades;

Acceleration of planned network upgrades in compliance with state or federal requirements; and

Extension and modification of network facilities or operational support systems, including databases and electronic interfaces.

USWC claims that the network rearrangements are necessary to provide its competitive local exchange carriers (CLECs) with interconnection, access to unbundled network elements, and the ability to resell retail services. 47 U.S.C. § 151 et seq. USWC has identified the following costs for the rearrangements (collectively referred to as network rearrangement costs):

Previously incurred systems costs for software changes to allow for service assurance, capacity provisioning, and billing and service delivery for CLECs;

Costs currently incurred for network modifications for anticipated traffic demands arising from the CLECs; and

Costs currently incurred to establish service centers to process CLEC service orders.

USWC states that, through the third quarter of 1996, it incurred more than $16 million for network rearrangements in its 14-state region. Staff estimates that Oregon's share of the $16 million is approximately $1.3 million. The ICAM generates $14 million in 1997 on a "total Oregon" (intrastate and interstate) basis.

USWC proposes to collect the $14 million from one of two groups. USWC's preferred revenue source is the CLECs. Under the ICAM, USWC would impose the following monthly surcharges on the CLECs, paid quarterly over a three-year period:

As another option, USWC suggests recovering interconnection costs through an end-user monthly surcharge of $0.74 per access line provided by the company.

Finally, USWC proposes a true-up mechanism to allow USWC to recover all network rearrangement costs for a three-year period commencing from the time of the Application. The cost recovery surcharge will be based on a rolling average for a 36-month period. There will be a second true-up mechanism to ensure USWC recovers all network rearrangement costs incurred during (and before) the 36-month period.

USWC is uncertain what network rearrangements will ultimately be required. As such, USWC reserves the right to add other cost categories to the ICAM. If USWC is able to recover the network rearrangements costs from other revenue sources, USWC will credit the ICAM.

OPINION

USWC makes numerous claims regarding the merits of the ICAM. USWC points out that we have previously acknowledged that there may be costs for interconnection that are not included in the rates for unbundled network elements. See Order No. 97-003 at 6-7. USWC also asserts that other proceedings before the Commission do not provide for recovery of the costs sought in the ICAM.

These assertions are not relevant to this phase of the proceeding. The only issue is whether USWC's chosen cost recovery mechanism, the ICAM, is legally permissible under state law. As we conclude below, the ICAM is fatally flawed.

Retroactive Ratemaking

The principal issue addressed by the parties is whether the proposed cost adjustment mechanism violates the rule against retroactive ratemaking. According to the Oregon Attorney General, retroactive ratemaking is:

(T)he setting of rates which permit a utility to recover past losses or which require it to refund past excess profits collected under a rate that did not perfectly match expenses plus rate-of-return with the rate actually established. (Citation omitted.)

Letter of Advice, March 18, 1987, (OP-6076).

OP-6076 was issued in response to a question from former-Commissioner Charles Davis regarding the legality of establishing balancing accounts which would be used to accumulate power costs above and below a predetermined level set by the Commission. Accumulated balances would be amortized to rates over a specified period of time. These balancing accounts would be authorized through deferred accounting orders. The purpose of the balancing accounts was to reduce the need for electric utilities to file for a rate adjustment each time power costs fluctuated. The Attorney General concluded that the proposed balancing accounts would have the effect of compensating the utility for past losses or would refund to the customers past excess profits. The Attorney General determined that the balancing accounts were impermissible absent authorizing legislation.

USWC claims that the rule against retroactive ratemaking only applies to adjustments made in a comprehensive ratemaking proceeding to account for excess profits or losses that have occurred since the last comprehensive ratemaking proceeding. USWC asserts that its ICAM is an addition to the existing tariff and not a comprehensive rate filing. It describes the ICAM as a pass-through of costs to the cost causers or end users for a discrete and readily identifiable set of start-up costs (1) that could not have been anticipated in prior rate proceedings and (2) that will occur only for the limited time it takes to prepare USWC’s network for interconnection, unbundling and resale for the CLECs.

OP-6076 does not distinguish between a pass-through provision in a general rate order and a pass-through provision in an accounting order. In fact, retroactive ratemaking is often requested because a utility incurs costs or receives revenues that were unanticipated in a prior rate proceeding. See ORS 759.200 (2) (listing the accounts for which the Commission may allow deferral of costs and revenues).

USWC's proposed ICAM results in retroactive ratemaking. USWC’s proposal addresses recovery for three groups of costs. The first is for costs incurred to reconfigure the network prior to filing this application. The second is for costs incurred after the filing, with refunds owing to the CLECs if the costs are less than the surcharges, as determined at the end of the three-year period. The third is for costs incurred in categories unanticipated at the time the ICAM is approved. This last group is to be recovered through a second surcharge at the end of the 36-month period.

As courts have made clear, there is no reasonable claim for costs incurred prior to the date the application was filed or for cost categories discovered after the ICAM is approved:

The rule against retroactive ratemaking serves two basic functions. Initially, it protects the public by ensuring that present consumers will not be required to pay for past deficits of the company in their future payments. The Supreme Court of New Jersey has expressed this legitimate concern as follows:

The present practice, as set forth in these cases, is fair to the public utility, for it can act as speedily as it sees fit to move for a correction of inadequate rates, and it is fair to the consumer in safeguarding him from surprise surcharges dating back over years that he had a right to assume were finished business for him and possibly over years when he was not even a consumer. New Jersey Power v. PUC, 15 N.J. 82, 93, 104 A. 2d 1, 7 (1954).

The rule also prevents the company from employing future rates as a means of ensuring the investments of its stockholders. Citation omitted. If a utility's income were guaranteed, the company would lose all incentive to operate in an efficient, cost-effective manner, thereby leading to higher operating costs and eventual rate increases.

OP-6076 at 2-3, citing Narragansett Elec. Co. v. Burke, 415 A2d 177, 178-79 (RI 1980).

The ICAM violates the rule against retroactive ratemaking because it denies customers their right to know the rates they are paying for service and their right to be free from surprise surcharges after the service has been provided.

The provisions of the ICAM that impose surcharges based on prospective expenditures also violate the rule against retroactive ratemaking. As pointed out by the Joint Parties, the ICAM includes a balancing mechanism legally indistinguishable from the mechanism addressed in OP-6076. In effect, the ICAM allows USWC to book its actual costs and revenues related to unbundling network elements, interconnection, and resale. At various times, the revenues will be balanced against costs. Future charges would be adjusted to clear the amount in the balancing account from that earlier period.

During the true-up process, the Commission determines whether refunds or additional surcharges are necessary based on past performance. Retroactive ratemaking is involved because the actual imposition of the rate occurs at the time of the true-up. Collections from the customers prior to the true up are held in a balancing account, escrowing revenues in anticipation of a future claim. Since the rate is charged after the costs are incurred, the rule against retroactive ratemaking is implicated.

Legislative Authorization for the ICAM

As OP-6076 points out, a legislature can explicitly authorize a regulator to set rates retroactively. USWC points to several provisions of the Oregon statutes that it claims provide authority for the Commission to approve the ICAM. We therefore turn to the Oregon statutes to determine whether there is legislative authorization for the ICAM.

General authority to approve the ICAM. USWC asserts that the provisions of ORS 756.040(2) and ORS 759.015 authorize the Commission to approve the ICAM. ORS 756.040(2) authorizes the Commission to "do all things necessary and convenient in the exercise of ¼ (its) power and jurisdiction." ORS 759.015 requires the Commission to authorize cost recovery "by a balanced program of regulation and competition."

These arguments directly contravene OP-6076. The Attorney General stated:

Because ratemaking is a legislative function and substantive legislation is applied prospectively absent explicit direction to the contrary, a ratemaking order that has retroactive effect is lawful only if specifically authorized by the legislature and cannot be supported only by the commissioner’s general powers.

. . . We conclude that the commissioner’s general power "to do all things necessary and convenient" . . . does not authorize the commissioner to issue a deferred accounting order.

(OP-6076 at 9-10.)

USWC further argues that, pursuant to ORS 759.175, it must file tariffs setting forth all rates, tolls and charges that it collects for its services. USWC claims that rates that do not compensate it for unrecovered costs or that discriminate against other classes of customers by forcing them to help absorb the unrecovered costs are neither just nor reasonable. USWC's argument is unpersuasive. USWC can only recover its costs through a rate mechanism that is within the Commission's power to approve. ORS 759.175 does not provide independent authority to approve the ICAM.

Specific authority to approve the ICAM. USWC claims that ORS 759.050(2)(c) gives the Commission "clear authority" to impose the ICAM charges on CLECs. USWC cites the statute as follows:

At the time of certification of a [competitive] telecommunications provider, or thereafter, the commission may impose reasonable conditions upon the authority of the telecommunications provider to provide competitive zone service within the competitive zone including, but not limited to, conditions designed to promote fair competition, such as interconnection, and contributions of the type required of a telecommunications utility . . ..

This statute does not provide the Commission authority to impose an ICAM charge on CLECs. A full reading of ORS 759.050(2)(c) indicates that USWC is citing the statute out of context. The omitted language from the above citation provides:

. . . on account of the provision of local exchange service, including those to the Residential Service Protection Fund or the Telecommunications Devices Access Program.

The Residential Service Protection Fund and the Telecommunications Devices Access Program are authorized at the end of Chapter 759. These provisions establish end-user surcharges to promote universal service. The legislature authorized the Commission to require the CLECs to make contributions to promote universal service. There is no express authorization to include prior profits or losses in future rates.

USWC next claims that ORS 759.180(1) provides the Commission authority to approve the ICAM. USWC asserts that the ICAM can be considered an automatic adjustment clause (AAC). We disagree.

An AAC is:

…a provision of a rate schedule, authorized pursuant to ORS 759.195(6), which provides for rate increases, or decreases or both, without prior hearing, reflecting increases, decreases or both in costs incurred by a telecommunications utility and which is subject to review by the commission at least once every two years.

ORS 759.180(1).

In OP-6076 at 16, the Attorney General concluded that ORS 757.210(1), a statute nearly identical to ORS 759.180(1), lacks an explicit statutory declaration authorizing retroactive ratemaking. The Attorney General concluded that the Commission is only authorized to include fixed rate AACs in utility tariffs. The fixed rate tariff:

. . . uses costs incurred in the past month to estimate current expenses. Each month acts as a test period for setting (fuel) costs for the following month. Under a fixed rate tariff, deferred billing is not permitted because the fixed rate tariff is intended to estimate cost and not to provide recovery of actual costs. Thus, surcharges are not authorized under a fixed rate fuel adjustment clause.

(OP-6076 at 15.)

We find that the Commission cannot approve the ICAM under its authority to include AACs in utility tariffs. First, the ICAM, as we have determined above, would result in retroactive ratemaking. ORS 759.180(1) does not provide authority to approve retroactive ratemaking. Second, the ICAM is not a fixed rate tariff. A fixed rate tariff is a permanent rate, based on costs estimated for the period the rate will be in effect. The adjustment is not subject to refund. In contrast, the ICAM is not a permanent rate until the time of true-up. USWC's assertion that the ICAM authorized by ORS 759.180(1) is not adopted.

Staff points out another reason why an AAC, under ORS 759.180, cannot be used to approve the ICAM. The AAC in ORS 759.180(1) is limited to rate schedules authorized pursuant to ORS 759.195(6). The latter section refers to the process for designating essential services as ineligible for pricing flexibility under ORS 759.195. Because the Commission has not designated the ICAM as an essential service, Staff asserts that the AAC provision of ORS 759.180 is inapplicable. We agree.

USWC claims that, even if AACs were limited to essential services, the Commission has already placed interconnection and unbundling in the category of essential services by classifying the services as essential functions in Order Nos. 94-1851 at 4 and 96-021 at 8. This argument is inaccurate.

USWC is aware that the Oregon Legislature and this Commission distinguish between essential functions and essential services. The distinction is explained in the very provisions of the Commission orders that USWC cites, as well as Order No. 95-313 at 3-4. As we have noted in those orders, essential functions, as defined in ORS 759.050(1)(c), are functional components of telecommunications services. These functions are also telecommunications services under ORS 759.005(2)(g) and 756.010(8). In contrast, ORS 759.195(6) specifies that essential services are those services designated as such in a rulemaking proceeding. Consequently, an essential function is not an essential service unless the Commission confers that status by rule.

USWC also claims that ORS 759.200 allows the Commission to approve the ICAM as a form of deferred accounting. We conclude that the provisions of ORS 759.200 do not apply to the cost categories included in the ICAM.

The provisions of ORS 759.200 must be interpreted narrowly. First, as the Attorney General has pointed out, exceptions to the rule against retroactive ratemaking must be explicit. OP-6076 at 10. Second, the statutory context evinces a legislative intent to narrowly circumscribe deferred accounting for telecommunications utilities. ORS 759.200 must be compared to ORS 757.259, the statute authorizing deferred accounting for energy and water utilities. ORS 757.259 allows the Commission to defer any increase or decrease in revenues or expenses to minimize the frequency of rate changes or to match costs borne and revenues received by ratepayers. In contrast, ORS 759.200(2) provides a detailed list sharply limiting the allowable accounts for which deferred accounting is authorized.

USWC points to ORS 759.200(2)(j) and (6) as authority for the Commission to approve the ICAM through deferred accounting. USWC first claims that ORS 759.200(2)(j) allows the Commission to defer expenses associated with interconnection, resale, and unbundling, since the expenses are planned to occur in connection with certain types of service contracts. That provision states:

(2) Upon application of a telecommunications utility or ratepayer or upon the commission’s own motion and after public notice and opportunity for comment, the commission by order may authorize deferral, for later incorporation in rates, telecommunications utility expenses or revenues, the recovery or refund of which the commission finds should be deferred in order to minimize the frequency of rate changes or the fluctuation of rate levels or to match appropriately the costs borne by and benefits received by ratepayers. The authority under this subsection is limited to the following accounts:

(j) Increases or decreases in amounts incurred by a telecommunications utility from customer service contracts, intercompany service contracts and joint and through service arrangements.

We conclude that ORS 759.200(2)(j) authorizes deferrals associated with specific contracts, not generalized expenditures associated with a group of contracts. As a result, this statute is not applicable to the category of costs USWC proposes to recover through the ICAM.

As USWC admits, the network rearrangement costs to implement interconnection, unbundling, and resale are not easily attibutable to individual agreements between CLECs and USWC. These are common costs incurred to meet the mandates of the Act and the competitive zone statute (ORS 759.050). Adopting USWC's interpretation of the statute would expand the Commission's authority to order deferrals for any cost incurred in connection with customer service contracts, without reference to a particular contract. We cannot adopt USWC's interpretation of ORS 759.200(2)(j) without creating an exception that swallows the rule.

USWC also cites ORS 759.200(6), as authority to approve the ICAM:

The provisions of this section may be used as a means of deferring the effect of readily identifiable and readily measurable changes in particular costs or revenues of a telecommunications utility, but shall not be used to implement a claim for an increase or decrease in the overall revenue requirement of a telecommunications utility when the amount of the change or changes would not be known until the completion of a rate case.

This provision is a limitation on the categories listed in subsection (2). It cannot be used as an independent ground for Commission authority to require retroactive ratemaking.

USWC also points to ORS 759.210 as authority for the ICAM. This section authorizes classifications or schedules of rates applicable to individual customers or groups of customers. USWC argues that the CLECs represent a special class of customers and the ICAM will simply ensure that they pay their fair share of the costs they impose by demanding interconnection, unbundling, and resale. While we agree that CLECs are a special class of customers and that we may establish a rate schedule for those customers, this statute is not an express legislative authorization to engage in retroactive ratemaking.

Finally, we find no basis to conclude that ORS 759.100, .110, and .130, authorizing review of annual budgets and auditing of USWC's accounts, authorize retroactive ratemaking.

Discrimination and Barriers to Entry

The Joint Parties and Sprint claim that the ICAM is discriminatory because:

Requiring the first CLECs to pay the costs of network rearrangements favors later entrants who will get a "free ride."

Requiring CLECs to pay the cost of network rearrangements favors USWC and its customers who will originate calls to and terminate calls on, the CLECs’ networks.

Requiring CLECs to pay for network upgrades discriminates in favor of independent incumbent local exchange carriers who interconnect with USWC and who are not required to pay the ICAM.

The Joint Parties and Sprint claim that the ICAM is a barrier to entry because:

It creates uncertainty in that CLECs cannot predict the cost of interconnection.

It puts new CLECs on notice that USWC will seek to impose new charges beyond the charges approved in the arbitrations under the Act and proceedings to establish the rates for unbundled network elements.

The rate is so high (as much as $73,000 per month for 36 months) that CLECs will be unable to afford the entry fee.

The Commission cannot determine whether these arguments have merit without a hearing to explore the factual underpinnings for the allegations. As we conclude below, such hearings are unnecessary.

USWC's Options for Recovering Network Rearrangement Costs Outside a Revenue Requirement Proceeding

We recognize that our conclusion here leaves USWC with few options, outside the arbitration process under the Act, for recovery of the costs it claims that it will incur to rearrange its network to accommodate the CLECs. In large part, this problem is one of USWC's own making. USWC failed to raise the issue in UT 125, where it was most appropriate to do so. In addition, USWC, along with other telecommunications utilities, opposed legislation in 1989 that would have provided the Commission authority to approve deferred accounting provisions that would have encompassed the ICAM. Under the current statutory scheme, we see few options for USWC other than to wait until UT 125 is completed and refile a new rate case that includes the purported cost of network rearrangements, or to use the dispute resolution procedures set forth in individual arbitration agreements.

CONCLUSION

USWC has failed to provide the Commission with a legal basis for adopting the ICAM. The operation of the ICAM would constitute retroactive ratemaking. The ICAM does not fit any of the statutory exceptions that authorize retroactive ratemaking. As a result, the Commission has little choice but to permanently suspend USWC's ICAM filing.

ORDER

IT IS ORDERED that the Interconnection Cost Adjustment Mechanism filed by U S WEST Communications, Inc., is permanently suspended.

Made, entered, and effective ____________________________.

A party may request rehearing or reconsideration of this order pursuant to ORS 756.561. A request for rehearing or reconsideration must be filed with the Commission within 60 days of the date of service of this order. The request must comply with the requirements of OAR 860-014-0095. A copy of any such request must also be served on each party to the proceeding as provided by OAR 860-013-0070. A party may appeal this order to a court pursuant to ORS 756.580.