Competitive Implications of Forbearance Petitions (Cost Assignment and ARMIS) and the Special Access Debate Presentation to NARUC Staff Subcommittee on Accounting and Finance October 14, 2008 Ron Hilyer, Director – Regulatory Accounting, AT&T

2 Reality There are no negative competitive implications from the Forbearance Petitions. In fact, cost assignments and ARMIS reporting have been totally unrelated to special access pricing for many years – since the FCC transitioned from cost based rate-of- return regulation to price caps.

3 Overview Cost Assignment Forbearance Relief Granted Requirements/Conditions Remaining FCC Rationale for Forbearance Issues with Cost Assignment ARMIS Data ARMIS Forbearance Relief Granted Requirements/Conditions Remaining FCC Rationale for Forbearance

4 Cost Assignment – Relief Granted AT&T Petition granted April 24, 2008; same relief granted to Verizon and Qwest on September 6, 2008 Forbearance from Part (Non-regulated activities) Part (Transactions with affiliates) Part 64, Subpart I (Allocation of Costs) Part 36 (Jurisdictional Separations Procedures) Part 69, Subparts D and E (Cost Apportionment)

5 Cost Assignment – Relief Granted (continued) Forbearance from ARMIS 43-04, Access Report FCC Form 492, Rate of Return Monitoring Report FCC Form 495A, Reg/Non-reg Forecast Report FCC Form 495B, Reg/Non-reg Actual Usage Report

6 Cost Assignment – Related Accounting Requirements/Conditions Remaining ARMIS 43-01, Annual Summary Report* ARMIS 43-02, USOA Report ARMIS 43-03, Joint Cost Report* Part 32, USOA (except for and 32.27) Upon request by the FCC, useable information must be provided on a timely basis Section 272(e)(3) Section 254(k) and Annual Certification Approval of a Compliance Plan * except for data generated by application of the Cost Assignment Rules

7 Cost Assignment – FCC Rationale for Granting Forbearance Enforcement of the regulations not necessary to ensure that charges and practices are just, reasonable, or not unjustly or unreasonably discriminatory in a price cap regulation environment where prices are not set based on costs Consumers are protected from unjust and unreasonable rates through price regulation and competition

8 Cost Assignment – FCC Rationale for Granting Forbearance (continued) Costs incurred to comply with the Cost Assignment Rules outweigh the benefits. These costs likely distort the market for telecommunications services by diverting resources that would otherwise be directed to “positive activities that generate consumer benefit”

9 Cost Assignment – Issues with ARMIS Data Jurisdictional and Part 69 element specific cost assignment results are not reliable and thus couldn’t be used for pricing decisions anyway

10 Cost Assignment – Issues with ARMIS Data – continued Regulatory bodies have recognized that cost assignment rules in place did not produce meaningful and reliable results FCC: separations rules were “outdated regulatory mechanisms that are out of step with today’s rapidly-evolving telecommunications marketplace.” (Separations Freeze Order, May 2001) State members of the Separations Joint Board: “concern that then-existing separations process was cumbersome, pretended to accuracy it could not achieve, and was fundamentally disconnected from pricing decisions.” (Glide Path Paper, December 2001)

11 Cost Assignment – Issues with ARMIS Data – continued The Separations Freeze implemented by the FCC in 2001 coupled with the evolving internet and broadband technologies even further deteriorated the reliability of the data especially for service-specific ratemaking purposes

12 Cost Assignment – Issues with ARMIS Data – continued Under the separations freeze, most revenues were based on current period actual results and not impacted by allocations. However, costs were based on arbitrary allocations of total book costs using allocation factors that were several years old and based on the way carriers operated in the late 1990s. Thus, the results reflected a mis-match of revenues and costs The impact of this mismatch is particularly apparent in special access because of the significant growth in special access traffic driven by the rapidly increasing use of the internet and broadband technologies

13 Total BOC Access Lines and Revenue Trends (In Millions) Cumulative % Growth Special Access Lines % Special Access Revenue $7,119$17, % Switched Access Lines % Common Line And Traffic-Sensitive Revenue $18,238$12, % Source: ARMIS 43-08, Table III for Access Lines. ARMIS for Revenue.

14 Source of underlying data is ARMIS report, rows 1090, 1650, 1660 and 1690, columns (s) and (f).

15 Source of underlying data is ARMIS

16 ARMIS – Relief Granted AT&T Petition granted September 6, 2008; same relief granted to all carriers Forbearance from ARMIS 43-05, Service Quality Report Installation & Repair Intervals Common truck blockage reports Total Switch Downtime Occurrences of 2 minutes or more downtime Customer Service Quality complaints

17 ARMIS – Relief Granted (continued) Forbearance from ARMIS 43-06, Customer Satisfaction Report Results of ILEC customer satisfaction surveys ARMIS 43-07, Infrastructure Report Number of local switches Length of loop and transport facilities by cable type (e.g. sheath kilometers of copper cable) ARMIS 43-08, Operating Data Report Outside plant statistics (e.g. kilometers of aerial cable) Access lines in service by state Call volumes by state

18 ARMIS – Remaining Requirements/Conditions Carriers will continue to file ARMIS and for 24 months Carriers will continue to maintain the ARMIS and data for 24 months No forbearance granted for business switched access lines and total switched access lines reported in ARMIS NPRM seeking comments on whether and how data on an industry-wide basis should be collected

19 ARMIS – FCC Rationale for Granting Forbearance Reports not necessary to ensure carriers’ rates, terms, and conditions were just and reasonable, or not unjustly or unreasonably discriminatory “Reports were adopted to monitor the “theoretical concern” that price cap carriers might reduce service quality or network investment to increase short-term profits, rather than being designed to address the rates, terms, and conditions under which carriers offered their services”. That was nearly 20 years ago There is no federal need for the data in these reports (except for business and total switched access lines) Partial and uneven data collection limit usefulness as a consumer protection tool

20 Key Takeaways Cost assignment data no longer relevant in a price cap environment Cost assignment data was never intended to be used for service-specific ratemaking Cost assignment data no longer reliable due to evolving technology and separations freeze ARMIS forbearance has no immediate impact due to commitment/condition to file or maintain data in ARMIS 43-05, 43-06, 43-07, and for 24 months