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The following article appeared in the Spring 2008 edition of CalCom Connect, the magazine of the California Communications Association:

The California High Cost Fund, known in abbreviated form as the CHCF, has been part of the state regulatory process for telephone companies since long distance competition was introduced and the local Bell operating companies were divested from AT&T. It has evolved and now has two components, the CHCF-A and CHCF-B. The life of these two funds is limited by law. Pending state legislation would extend the authorization for the two CHCF programs from their current sunset date of January 1, 2009 until January 1, 2013. As the state legislature considers extending these programs, the historical contribution and future need for these funds in facilitating the deployment and continued availability of basic telephone service in high cost areas should be remembered.

When long distance competition was first introduced, a new system for compensating the local telephone companies was needed. Under the new system, long distance companies provided what was designated as interLATA toll service, and they were assessed access charges by the local telephone companies for the origination and termination of long distance traffic. The new access charge framework led to the establishment of the CHCF.

The original CHCF was adopted in 1985 and then implemented in modified form in 1988. The California Public Utilities Commission (CPUC) ordered rate reductions for toll services in anticipation of a further expansion of competition and adopted rate changes for the access charges paid by long distance companies. This order, however, would not have affected just Pacific Bell since nearly all other California telephone companies had adopted Pacific Bell’s rates for toll and access services. Therefore, changes in Pacific Bell’s rates would have necessarily changed the rates of many other companies, too. In 1965, however, the California Supreme Court held that any changes in rates for jointly-provided services could not be made unless and until all affected companies also had hearings addressing the impact of the rate changes on them.

Timely implementation of the 1988 rate changes were deemed crucial for competition. Therefore, to allow the rate changes to be made without violating the California Supreme Court’s 1965 decision, the CPUC adopted a joint proposal of the parties to implement the CHCF based on a concept of revenue neutrality. This would permit changes to statewide rates for toll and access services, including the toll and access rates of those local telephone companies that had adopted Pacific Bell’s tariffs, without the legally-required hearings on the impact of the rate changes on every affected telephone company. This is because the CHCF process ensured there would be no revenue impact on these companies. The original CHCF process involved quantifying the impact of the statewide rate changes on each company and providing offsetting adjustments for each company consisting of limited basic rate increases up to 150% of Pacific Bell’s basic rate with any additional shortfall funded through the CHCF.

The CHCF was refined over the years to ensure that recipients of its funding would not draw what the state commission deemed to be excessive funding. It was subject to a “waterfall” by which potential CHCF draws would be reduced if formal rate cases were not undertaken regularly. In 1991, an annual means test was added to cap each recipient’s potential revenue from the CHCF to an amount projected necessary to allow it to achieve its authorized earnings level.

Historically, telephone companies have been rate base regulated public utilities whose rates have been set at levels that were forecasted to afford a reasonable opportunity for them to recover their costs of doing business plus a return on the assets devoted to their business. Smaller telephone companies in California remain rate base regulated. Larger telephone companies are no longer rate base regulated.

Until 1996, the CHCF was relevant only to the smaller rate base regulated companies. In 1996, the PUC adopted its watershed universal service order. The original CHCF was renamed the CHCF-A, the name it retains to this day. A CHCF-B was established for the larger telephone companies to provide support for the provision of service in high cost areas of their service territories. The purpose of the CHCF-B is to ensure residential basic telephone service remains available in areas of California served by the larger telephone companies and that the rates for such service remain affordable as competition grows in the telecommunications industry.

Some argue that outside support distorts the market. Legislators and regulators have introduced mechanisms such as the CHCF-A and CHCF-B to promote access to telephone service at reasonable rates in areas where the capital investment needed to extend service would not be justified based on anticipated revenues from subscribers. As a point of comparison, the implementation of airline deregulation without a similar policy commitment has led to the loss of commercial passenger service in many smaller markets.

Thus, the CHCF, and its counterparts in other states and at the federal level, promote important public policy goals. They do so by allowing increasing levels of telecommunications competition to be introduced without adversely affecting subscribers who would be too costly to serve. Therefore, in the interest of universal service, regulators and legislators should continue to look to these mechanisms to protect the availability of telephone service at reasonable rates in high cost areas.

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