The telecom subsidy regime: One of life’s great mysteries, explained

When the CRTC opened its hearing on access to basic telecom services last month, there were more than enough topics for debate. Whether the commission should mandate broadband as a basic service, modify its subsidy regime, or increase price caps, were among the many points of contention. But during the two-week long hearing, a common refrain stood out in conversations about the subsidy regime: “I don’t understand.” When it came to the commission’s telecom subsidy regime, parties were clear on what they wanted out of the policy, but much less precise on the inner workings of the regulatory mechanism itself. Under the subsidy regime, funds are collected from telecom providers and redistributed to incumbents Bell Aliant, Telus Corp., MTS Allstream, SaskTel and NorthwesTel to fund basic telephone services in higher-cost rural and remote areas. Some interveners at the hearings argued that the regime is necessary to provide affordable, basic services in high-cost areas, but others said the regime needs review and is founded on an outdated methodology. On the first day of the hearings, Bell Aliant argued that incumbents in Western Canada are favoured by the regime, receiving more than six times the subsidy than Bell Aliant. During the proceeding, The Wire Report asked Mirko Bibic, Bell Canada’s senior vice-president of regulatory and government affairs, how such a situation could come about under the commission’s supervision. The answer was telling: “It’s a great mystery.” Some sources said, half seriously, that there may only be a small handful of people on the planet—all of them within the CRTC—who fully understand the subsidy regime. In an effort to try to shed some light on one of life’s great mysteries, and clear up confusion about how the subsidies are calculated, The Wire Report spoke with John Macri, the CRTC’s director of policy. The following interview has been edited for style and length. People don’t seem to understand how the subsidy regime works. How are the subsidies calculated? It starts from the premise that in certain areas of the country, the rate that is charged for the service is actually lower than the cost of providing the service. What we’ve done is we’ve divided the country into what we call bands. We have a Band A that is low cost, and it goes right through to Band G. The costs in those bands vary and the rates vary. We determine what that differential is between the rates and the costs. Then we look at some of the extra services that are part of that local service: for example, voice mail and call display. Those are additional services that help reduce some of the shortfall. We take that as a very general formula—the rate minus the cost, minus those additional revenues—to figure out what the shortfall is. It’s calculated for each exchange within the band, summed up by band, and that’s within the incumbent territory. For example, Bell Aliant has high cost bands E, F and G. Within each of those bands, there are exchanges that are classified as E, F and G. We add up all of those shortfalls to come up with a shortfall total for Bell Aliant for its entire territory. So the subsidies are calculated for each company? No, it goes down to the per-line basis. It starts at a per-line basis. Then we add it up to get a total. The reason why I’m adding that up to get to a total is because we have to actually collect it from someone. There’s a collection side and there’s a distribution side. Is this calculated every year? Yes, once a year. We figure out an amount for Bell Aliant, and then we do the same thing for the other incumbent companies and we come up with a total. I believe it was about $160 million or $170 million this year. Then what we do is we turn around and say, “Alright, all the telecommunications service providers in Canada that have revenues in excess of $10 million, you will contribute a percentage of your revenues to help fund this shortfall of $170 million.” They report to us the amount of revenues that they have, and we calculate a base. That base is in the billions of dollars, about twenty-four to $25 billion. So we take the $170 million that we need to distribute and we divide it by the base of $25 billion, and that gives us a 0.73 per cent charge. Then we turn around and collect 0.73 per cent of the revenues of those qualifying companies, put it into the fund to get to the $170 million, and then distribute it back on a per-line basis. Are there additional factors you consider when calculating how much it costs to serve a region, such as population density? Back in 2001, we created the general rules about how exchanges get classified into various bands. A lot of it was based on the length of the loop, or the line to service each customer. It was also based on the number of lines you have within each exchange. So you have certain criteria to determine how an exchange gets classified within a band. This is what companies were talking about : “Maybe we should change some of those rules, maybe we should look at things like population density, and split up those definitions and do sub-bands.” But how do you calculate the cost of serving now? We have what’s called certain costing principles, which we’ve been using for many, many years. What it looks at is, what would be the cost to build and service the facilities, and what is the incremental cost of doing that? Each of the companies has performed different studies or analyses of their costs. They give them to us and we’re the ones who analyze and approve them. There could be various differences between companies, in terms of the costs, based on the way they provision the service. We’re getting into very, very detailed criteria and methodology, but it’s using principles that we’ve established many, many years ago, and that the companies have accepted. Some of the detailed costing information is confidential. It’s not shared among the companies. They may look at the costs and wonder, “Why is it different?” But all the companies calculate their costs based on the same system? It’s based on the same methodology, but the inputs may be different because of their specific circumstances. There are rules and there are principles and procedures in place, but depending on certain circumstances, there is an opportunity to be very specific for a certain situation and calculate a cost maybe differently then you would in another territory. But I’m not an expert on that. I know that there are cost differences across the territories based on certain factors and assumptions that are made in the analysis, but I couldn’t even start to guess why or begin to even explain it. Price caps—how do they work? Price caps come along as a method of regulating prices, whether they be in high-cost areas or non-high-cost areas. So every area across the country has its own price cap? Well, that’s the way it started, way back when. Price caps are in place, but once you reach a level of competition, price caps no longer apply. The way price caps work in high-cost areas right now is companies in high-cost areas can increase rates on an annual basis by the rate of inflation. But what we’ve said is, whether or not you increase those rates to your prescribed limit, we will reduce the amount of subsidy you’re entitled to on an annual basis by that equivalent amount. In some cases the companies have not taken the price increase. So essentially what they’re doing is losing subsidy but they’re not recouping it through a price increase. How do you determine what the price cap is for each exchange? In 1997 we established what the going-in rate was, the rate in effect at the start of the price cap period. The companies over time have had the opportunity to modify those rates based on the parameters. So it was set once in 1997 and it just sort of rolls forward each year. We basically accepted the rates that they had and made a couple of adjustments because of the transition from profit regulation to price regulation. Can companies apply to increase a price cap by more than the cost of inflation? No, but the formula has had different variations over the years. We’re in our third generation in terms of how you can change prices. More or less, the increases have to stay within the rate of inflation. But there have been cases where a company has come in and said they had a very special circumstance happen, and this is outside the rate of inflation parameter, so they ask to increase the rate a little bit more that year. That has happened on occasion, for example, if we asked them to incur certain costs to implement something as part of their service. I have heard of cases where the price cap for one serving territory varies greatly from that of the neighbouring territory. How did this come about? It could have been the different circumstances in the beginning. We didn’t go through an extensive analysis across the country to figure out what should be the rate across the country and across a certain band. We essentially accepted the rates that were there, with some minor adjustments. Over time they may have been built up differently. kfournier@thewirereport.ca

The telecom subsidy regime: One of life’s great mysteries, explained

News | November 12, 2010

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