Rate-of-Return Operating Expense Limitation Now Includes Inflation Adjustment; FCC Tweaks Corporate Operations Expense Limitation

The Federal Communications Commission (“FCC”) has released a Report and Order, Third Order on Reconsideration, and Notice of Proposed Rulemaking that continue the FCC’s efforts to reform the high-cost universal service fund (“USF”) rules that apply to rate-of-return incumbent local exchange carriers.[1]

In the Third Order on Reconsideration, the FCC, among other things, revises the formula for calculating a rate-of-return carrier’s operations expense (“opex”) limitation to include an inflationary factor. Though revising the calculation won’t result in significant increases to opex limits, it will provide some relief by accounting for rising costs year-to-year. Additionally, the FCC makes a revision to its rules to include broadband-only loops when calculating a rate-of-return carrier’s corporate operations expense limitation. Below is a summary of these two revisions.

Background: Limitation On Legacy Rate-of-Return Carriers’ Recovery Of Operating Expenses

To incent rate-of-return carriers “to be prudent and efficient in their expenditures,” the FCC’s 2016 Rate-of-Return Reform Order imposed a limitation on operating expenses that are eligible for recovery under high-cost loop support (“HCLS”) and Connect America Fund Broadband Loop Support (“CAF BLS”).[2] The opex limitation, built on a regression methodology, limits opex costs by comparing a study area’s opex cost per location to the regression model-generated opex per location plus 1.5 standard deviations.[3] If a carrier’s study area is found to have expenses above the opex limitation, the carrier faces a reduction in support.

Penalties for exceeding the limit apply proportionately to the accounts used to determine a carrier’s eligible opex for HCLS and CAF BLS. For example, if the regression methodology determines a carrier’s eligible operating expense should be reduced by 10 percent, then each account used to determine that carrier’s eligible operating expense is reduced by 10 percent.[4] The opex limitation was subject to a one-year transition. For the rule’s first year, eligible opex of carriers over the limit were reduced by only one-half of the percentage amount determined by the regression methodology.[5] High-cost USF support reclaimed from carriers that exceeded their opex limitation is made available and redistributed to other legacy rate-of-return carriers.

The opex limitation adopted by the FCC was based on a proposal by rate-of-return industry associations, with a few modifications. The industry associations’ proposal included an inflationary factor in the opex limitation calculation which would have made an annual adjustment to account for the percentage change in the United States Department of Commerce’s Gross Domestic Product–Chained Price Index (“GDP–CPI”). However, the FCC declined to include an annual adjustment for inflation, causing NTCA–The Rural Broadband Association to seek reconsideration of the opex limit formula.

FCC Revises Opex Limit Calculation To Include GDP-CPI Inflationary Factor – FCC Will Revisit The Inflation Adjustment In Five Years

In the Third Order on Reconsideration, the FCC has granted NTCA’s request to consider inflation when calculating the opex limitation. Specifically, the opex limitation calculation will now include a GDP–CPI adjustment factor, which will apply for a period of five years. At or near the end of that five-year period, the FCC expects to “revisit the inflation adjustment to assess whether it accurately reflects carriers’ experienced changes in costs and if it remains necessary to protect carriers from inflation-driven cost increases.”[6]

The inflation adjustments will be implemented beginning with expenses incurred in 2017. The FCC has concluded “[i]t would be administratively burdensome to apply the inflation adjustment to 2016 expenses because NECA has already made its annual filing setting 2018 HCLS amounts based on 2016 expenses. Therefore, the 2017 opex limitation will include a compounded inflation adjustment so as to account for the effects of inflation for 2016 expenses.”[7] The following list shows how the inflation adjustment is to be implemented:

• 2017 Expenses: 1.0273 Inflation Adjustment
• 2018 Expenses: 1.0128 Inflation Adjustment
• 2019 Expenses: As published in NECA’s Oct. 1, 2018 annual filing
• Subsequent Years: As published in the prior year’s NECA annual filing

Calculation Of Each R-o-R Carrier’s Corporate Operations Expense Limitation Will Include Consumer Broadband-Only Loops

Corporate operations expenses are considered general and administrative expenses, and typically include expenses related to company management, accounting and financial services, legal services, and maintaining relations with government, regulators, other companies, and the general public.[8]

In the 2011 USF/ICC Transformation Order, the FCC extended the limit on recovery of corporate operations expense to interstate common line support (“ICLS”). There was already a limit on the amount of corporate operations expenses that could be recovered from HCLS. The rule limits a carrier’s total corporate operations expenses based on the number of lines the carrier serves, and then apports those costs among common line (voice and voice-broadband lines) and other cost categories. The Rate-of-Return Reform Order did not change the way the corporate operations expense limitation is calculated, even though the ICLS mechanism was reborn as CAF BLS.

In its petition for reconsideration, NTCA argued the rule sets an inappropriately low limit on the corporate operations expenses for rate-of-return carriers with broadband-only lines, particularly those carriers with broadband-only lines making up a large part of their total lines in service (more broadband-only lines than voice and voice-broadband lines). Taken to the extreme, a carrier providing service exclusively with broadband-only lines would not be eligible to recover any of its corporate operations expenses.

Accordingly, the FCC has revised Section 54.1308(a)(4) of its rules to include CBOLs, along with voice and voice-broadband loops, in the calculation of each carrier’s corporate operations expense limitation.

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[1] Connect America Fund, WC Docket No. 10-90, ETC Annual Reports and Certifications, WC Docket No. 14-58, Establishing Just and Reasonable Rates for Local Exchange Carriers, WC Docket No. 07-135, Developing a Unified Intercarrier Compensation Regime, CC Docket No. 01-92, Report and Order, Third Order On Reconsideration, and Notice Of Proposed Rulemaking, FCC 18-29 (rel. Mar. 23, 2018) (Third Order On Reconsideration).

[2] Connect America Fund, WC Docket No. 10-90, ETC Annual Reports and Certifications, WC Docket No. 14-58, Developing a Unified Intercarrier Compensation Regime, CC Docket No. 01-92, Report and Order, Order and Order On Reconsideration, and Further Notice Of Proposed Rulemaking, FCC 16-33, ¶98 (rel. Mar. 30, 2016) (Rate-of-Return Reform Order).

[3] When it was adopted in 2016, the FCC estimated that, based on the previous year’s data, using 1.5 standard deviations would impact roughly 50 carriers.  See Rate-of-Return Reform Order at ¶100.

[4] See Rate-of-Return Reform Order at ¶98. The entire regression formula used to limit opex recovery is shown in paragraph 99 of the Rate-of-Return Reform Order.

[5] For example, if the regression methodology determined that a carrier’s eligible operating expense should be reduced by 10 percent for the first year, then each account used to determine that carrier’s eligible operating expense were reduced by only 5 percent.  However, in all subsequent years, a carrier’s eligible operating expense are reduced by the full percentage amount determined by the regression methodology. See Rate-of-Return Reform Order at ¶103.

[6] Third Order on Reconsideration at ¶85.

[7] Third Order on Reconsideration at ¶87.

[8] See 47 C.F.R. § 32.6720.