While reducing rates by $5.7 million for Citizens Utility Co. of California, a telecommunications local exchange carrier (LEC), the California Public Utilities Commission (CPUC) has also: 1) approved a new regulation plan for the LEC, 2) restructured rates to better position the LEC to operate in a competitive market, and 3) penalized the LEC 15 basis points on return on equity for failing to report ongoing service-quality problems.

The new regulatory framework contains the same price-cap formula, inflation index, and "exogenous factors" as the plan adopted for Pacific Bell and GTE California Inc. But the formula for earnings sharing between shareholders and ratepayers (equal sharing between the benchmark and ceiling rates of return; all earnings over the ceiling paid to ratepayers) mirrors the original plan adopted for Pacific Bell and GTE, rather than an updated version that eliminates sharing of earnings between the benchmark and ceiling rates.

The newly adopted cost-based rate design allows recovery of embedded costs for monopoly services, while limiting competitive services with price floors set at long-run incremental cost. The rate restructuring also attempts to remove existing cross-subsidies and to prevent the diversion of revenues from high- priced services to underwrite competitive ones. A general exception allows subsidization of rates for basic residential service.

While admitting that it historically failed to meet some service-quality standards, the LEC claimed that a rate penalty was unnecessary because it had already agreed to a series of scheduled improvements. Finding that the utility had earned an excessive rate of return and had reduced its workforce during the same period that service quality had declined, the CPUC ruled that an "additional incentive" in the form of a rate of return penalty was necessary to compensate ratepayers for ongoing inconvenience. Re Citizens Utility Company of California, Applications 93-12-005 et al., Decision 95-11-024, Nov. 8, 1995 (Cal.P.U.C.).

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