DE 96-420 FREEDOM RING, L.L.C. Petition Requesting that Incumbent LECs Provide Customers with a Fresh Look Opportunity Order Establishing Methodology for Calculating Termination Charges O R D E R N O. 22,877 March 23, 1998 I. PROCEDURAL HISTORY On December 8, 1997, the Commission issued Order No. 22,798 (Order) in this docket, granting customers of New England Telegraph and Telephone Company d/b/a Bell Atlantic (Bell Atlantic) a Fresh Look opportunity pursuant to certain conditions. One of the conditions requires that a customer choosing to terminate its long-term contract with Bell Atlantic will be subject to termination charges "in an amount equal to the price the customer would have paid for service if the customer had taken a term offering for the length of time the contract has actually run, minus the amount the customer has actually paid." Order at pages 25-26. The Order provided that the Commission Staff (Staff) and Bell Atlantic and Freedom Ring Communications, L.L.C. (Freedom Ring) would propose, by January 15, 1998, a methodology for calculating termination charges. Discussions among the parties and Staff resulted in agreement on the methodology for calculating termination charges for long-term special contracts and for termination of long-term contracts reached pursuant to tariff (long-term tariffed contracts). However, the parties and Staff disagreed on a critical input to the calculation, i.e., the capital cost factor. Therefore, on January 15, 1998, Staff filed a memorandum describing the agreed upon methodology for long-term special contracts, including the positions taken by each of the parties with regard to the capital cost factor, as well as Staff's recommendation on the capital cost factor. In addition, Staff requested that the Commission grant a one week extension for parties to file comments on Staff's memorandum. The Commission granted the extension and, on January 22, 1998, Bell Atlantic and Freedom Ring filed their comments. II. TERMINATION CHARGES FOR LONG-TERM SPECIAL CONTRACTS A. Methodology The proposed methodology compares two separate streams of cash flows. One stream includes the cash flow generated according to the original terms and conditions of a special contract between a commercial customer and Bell Atlantic up to the time of contract termination, including the capital cost factor in dispute. The second stream includes the cash flow generated pursuant to a revised set of contract terms and conditions, again, including the capital cost factor. The revisions adjust the customer's payment schedule and Bell Atlantic's expenses to reflect the actual time period of the contract. The difference between the two cash flow streams is then adjusted upward to reflect the time value of money or the interest Bell Atlantic would have earned on the cash flows generated under a shorter contract period. The result of these calculations is the proposed termination charge. For example, a customer making payments under a seven- year contract who elects to exercise its "Fresh Look" opportunity pursuant to Order No. 22,798 and terminates the existing contract at the end of three years would request Bell Atlantic to re-calculate the payment terms as if the contract were for a three- year period. The difference between the two payments is then adjusted to reflect interest foregone by Bell Atlantic. B. Capital Cost Factor The one disputed issue in the calculations is the magnitude of the capital cost factor to be applied. A capital cost factor is made up of depreciation, income taxes and return on capital invested by Bell Atlantic in order to deliver telecommunication services under a special contract. The termination charge is highly sensitive to this input factor. Bell Atlantic proposes a capital cost factor that incorporates one additional year beyond that actually identified in each contract. Thus, in the hypothetical example cited above, Bell Atlantic would use a capital cost factor for four- and eight-year term contracts rather than those for the actual three- and seven-year term contracts. Bell Atlantic argues that the extra year of capital cost is justified because it is the average length of time, according to Bell Atlantic, to re-use salvageable equipment. Bell Atlantic avers that at the time long-term special contracts are negotiated, the Company routinely utilizes the proposed higher capital cost factors. Therefore, Bell Atlantic argues that the higher factors should be utilized in this calculation. Freedom Ring, on the other hand, argues against using any time period beyond the actual terms of the contracts. According to Freedom Ring, any capital cost factor in excess of the actual terms of the contracts would enable Bell Atlantic to double recover its costs. Double recovery would occur, according to Freedom Ring, because the cost of capital already accounts for risks of early termination, including idle facilities. Further, Freedom Ring argues that using more than the actual term of the contracts is unsupported by any evidence on the record. As a result of the added costs of providing Bell Atlantic with enhanced cost recovery, competitive local exchange carriers (CLECs) will be unable to offer competitively priced services. Using the hypothetical example in Staff's January 15, 1998 memorandum, such a termination liability, according to Freedom Ring, represents a 40% penalty. Bell Atlantic's reported margin on Centrex service is approximately 25%. Therefore, the Bell Atlantic proposal will eliminate any margin for CLECs, effectively eliminating the incentive for CLECs to compete in New Hampshire. Freedom Ring argues that an 11% termination charge is sufficient to allow Bell Atlantic to recover legitimate capital costs without discouraging CLECs from competing. The 11% termination charge can be achieved by utilizing the actual terms of contracts. In the hypothetical example, the termination charge as calculated by Freedom Ring, would be $18,373. However, the cost of capital factor recommended by Bell Atlantic results in a termination charge of $174,159. Staff proposes a compromise position, utilizing a capital cost factor based on the actual contract term plus six months. For the hypothetical example, Staff's calculation results in a termination charge of $43,931. In support of its proposal, Staff argues that the compromise strikes a balance between the competing interests of compensating Bell Atlantic for its investments and that of fostering competition in New Hampshire's local telecommunications market. III. TERMINATION CHARGES FOR LONG-TERM TARIFFED CONTRACTS Consistent with the special contract methodology, Staff and the parties agreed that termination charges for long-term tariffed contracts should be equal to the future monetary value of the differences in customer payments between the original tariffed service and rates customers would have been charged over a shorter time period. However, because Bell Atlantic does not offer a Centrex service for less than seven year periods in New Hampshire, it was necessary to devise a method for creating a proxy New Hampshire rate based upon "Centrex Plus", a Massachusetts Centrex service with variable payment terms. The parties and Staff agreed the proxy rate should be established by applying the difference between various "Centrex Plus" payment plans, expressed as a ratio, to the New Hampshire seven-year rate. Applying the ratio to the New Hampshire seven year rate, creates a proxy rate which equates to the payment the customer would have paid over a shorter period. Bell Atlantic filed a spread sheet matrix computing the termination liability for New Hampshire Centrex service, using the above methodology (Attachment I, p. 1). When considering whether to take advantage of Fresh Look, in most instances a prospective customer can calculate exact termination charges by using Attachment I. Attachment I, p. 1 shows that the proxy rate for Central Office Common Equipment, Vintage I, Schedule A charges is 4% higher for a five-year term than for the tariffed charges (for the seven-year term). The increase allows Bell Atlantic to recover its capital costs over the shorter time period. The interest foregone by Bell Atlantic is then computed by calculating the future value of the difference between the seven-year and five-year payments using an interest rate of .99384 percent. Applying the same calculation to other components of the Centrex service, the termination charge for a 15-line Centrex service would be $524.79 for a customer electing to terminate a seven-year tariffed contract at the end of five years. The termination charge assumes a 15-line Centrex service within .5 miles from the wire center and includes an access line component (conduit and network access) and a feature component. See Attachment I, p. 2. IV. COMMISSION ANALYSIS Our decision to grant a limited Fresh Look opportunity is "intended to provide an opportunity for competition to flourish, not to punish Bell Atlantic for past actions which may have anti-competitive consequences in the present...(it is therefore) crafted to ensure that when and if a customer decides to accept the opportunity, Bell Atlantic is not deprived of the reasonably anticipated benefit of its bargain". Order at page 18. The calculation of termination charges must balance those two goals. We ordered the Parties and Staff to propose a methodology which would accomplish the balance, directing that customers be "subject to termination charges equal to the price the customer would have paid for service if the customer had taken a term offering for the length of time the contract has actually run, minus the amount the customer has actually paid." Id. at p. 26. We find that the methodology proposed by the parties and Staff for both long-term special contracts and long-term tariffed contracts, as described above, complies with our Order No. 22,798. We further find that the capital cost input factor proposed by Staff best meets our goal of balancing the interests of competition and Bell Atlantic's right to retain the reasonably anticipated benefit of its contractual bargain. The amount of time necessary for Bell Atlantic to find a new customer capable of using the salvageable equipment formerly used by the Fresh Look customer cannot be determined in advance. Therefore, six months is a reasonable compromise of Bell Atlantic's claim for one year or Freedom Ring's claim for no additional time beyond the actual term. Attachment I calculates the termination charge for customers who terminate a contract after 12, 24, 36, 48, 60 or 72 months. The future value calculation should be computed using the actual number of months the customer has had service. We will direct Bell Atlantic to file a matrix which includes factors for each month from on to 60. Customers who have had service for more than 60 months are not eligible for fresh look because they do not have two years remaining on the contract. Based upon the foregoing, it is hereby ORDERED, that the methodologies proposed for calculating the termination charges for long-term special contracts and long-term tariffed contracts are APPROVED; and it is FURTHER ORDERED, that the cost of capital factor for calculating termination charges for long-term special contracts shall be based on the actual term plus six months; and it is FURTHER ORDERED, that Bell Atlantic file a matrix which calculates termination charges for each month, from one to 60, for each tariffed Centrex service. By order of the Public Utilities Commission of New Hampshire this twenty-third day of March, 1998. Douglas L. Patch Bruce B. Ellsworth Susan S. Geiger Chairman Commissioner Commissioner Attested by: Thomas B. Getz Executive Director and Secretary NOTE: Attachment 1 is available by calling the Commission (603-271-2431). You can receive a copy by fax or mail.