March 30, 1994 OVERVIEW OF REVISED CABLE BENCHMARK REGULATIONS On February 22, 1994, the FCC adopted revised regulations that will be used by local and federal officials to assess whether rates for regulated cable services are reasonable, as required by the Cable Television Consumer Protection and Competition Act of 1992. These new rules become effective May 15, 1994. Cable rates that are regulated after this date will be evaluated under the new rules; rates in effect before that date will be judged using the FCC regulations that took effect last September. This fact sheet provides an overview of the revised benchmark regulations. It assumes a working knowledge of the Commission's initial benchmark approach for setting regulated cable rates at reasonable levels. The Commission's reasons for revising its benchmark rules are set forth in the Second Order on Reconsideration, Fourth Report and Order, and Fifth Notice of Proposed Rulemaking, MM Docket No. 92-266, released March 30, 1994. Further details on how to apply the new benchmark rules can also be found in the instructions to FCC Form 1200, which contains the specific calculations for computing reasonable rates that comply with the new benchmark regulations. Regulated cable systems that do not wish to use the benchmark approach when justifying rates to a local franchising authority or the Commission must submit a cost-of-service showing. The Old Benchmark System Under the Commission's initial regulations, regulated cable systems were required to apply a benchmark formula to help them determine whether they needed to reduce their current rates. Systems whose rates were at or below the benchmark rate produced by the formula were not required to reduce rates. However, rates for these systems were capped at the current rate and were allowed to rise only by inflation and to pass through certain external costs (defined below). Systems whose current rates were above the benchmark were additionally required to examine whether their rates were above or below the benchmark on September 30, 1992. If they were below the benchmark on that date, their permitted regulated rate was deemed to be the benchmark rate. If they were above the benchmark on September 30, 1992, they were required to reduce their September 30, 1992 rates by 10 percent or to the benchmark, whichever reduction was less. This 10 percent reduction stemmed from the Commission's initial finding that there was, on average, a 10 percent difference (the so-called "competitive differential") between the rates charged by competitive and noncompetitive cable systems. Cable systems that used their September 30, 1992 rates as a base rate in applying the benchmark approach were allowed to adjust those rates forward to reflect changes in inflation and in the number of regulated channels offered by the system since September 30, 1992. The specific calculations used to apply the old benchmark system are set forth in FCC Form 393. The New Benchmark Formula and Revised Competitive Differential In its February 22, 1994 decision, the Commission revised the benchmark formula to reflect a stronger statistical and economic analysis. The new benchmark formula will replace the old formula on May 15, 1994. In addition, the Commission determined, after further economic analysis, that the competitive differential is 17 percent, not 10 percent as it had originally estimated. Thus, regulated cable operators will be required to reduce rates by up to 17 percent from September 30, 1992 levels once the revised benchmark rules take effect. General Rule Generally speaking, the FCC's revised benchmark rules require cable systems to reduce their regulated rates to a level that represents their September 30, 1992 rates, reduced by 17 percent and then adjusted upward for certain allowed increases. Systems that do not make the rate reductions needed to bring their rates down to this level by May 15, 1994 will be subject to refund liability unless they can successfully show, through a cost-of- service showing, that their costs justify higher rates. The rate that regulated cable systems will be allowed to charge under the revised rules is called the "full reduction rate." To compute this rate, a system will take its September 30, 1992 regulated revenues per subscriber (a figure which includes revenues from both programming services and equipment) and subtract 17 percent. It will then add to the resulting figure: (1) the inflation that occurred between October 1, 1992 and September 1, 1993; (2) changes in external costs (defined below) that have occurred since the system became subject to initial regulation at either the local or federal level (or February 28, 1994, whichever was earlier); and (3) changes that have resulted from the addition or deletion of program channels to regulated service tiers since September 30, 1992. A regulated cable system whose rate is above its full reduction rate must reduce its rate to the full reduction level, unless it qualifies for transition relief (discussed below). Any cable system that sets its rate at the full reduction level will be entitled to adjust those rates in the future to reflect annual inflation, changes in external costs, and changes in the number of regulated channels. Refund Liability In general, regulated systems who select the benchmark approach to setting rates are required to comply with the revised rules by May 15, 1994 in order to avoid refund liability. To comply with the new rules, operators will need to collect the necessary rate- setting information, complete FCC Form 1200 to determine their new permitted rates, and give 30 days notice of any rate changes to their subscribers. Although the Commission is making every effort to ensure that this process runs as smoothly as possible (by, for example, making Form 1200 available on a computer disk), it is aware that some systems may have difficulty completing the necessary tasks before May 15, 1994. Thus, to reduce the burden on these cable systems, the Commission will not impose refund liability on them for an additional 60 days (that is, until July 14, 1994) as long as three conditions are met. First, systems wishing to take advantage of this deferral of refund liability may not change any rate for regulated service or equipment, or restructure any regulated service or equipment offering (by, for example, removing program channels from what would be regulated service tiers and placing them into an "a la carte" package), between March 30, 1994 (the release date of the Commission's rate decision) and July 14, 1994. If a cable system taking advantage of this deferral of refund liability nonetheless restructures its rates and service offerings before July 14, 1994, it will have its refund liability triggered on the date the restructuring occurs. Second, cable systems taking advantage of the refund deferral period must still give at least 30 days notice to subscribers of any rate or service changes they ultimately make in response to the new rules. Third, all rate and service restructuring must be completed by July 14, 1994 in order to avoid refund liability. Restructuring will be considered completed if bills reflecting any rate or service changes have been issued to subscribers by July 14, 1994. Transition Relief The Commission has decided that two classes of cable systems should not be required to reduce their rates by the full 17 percent competitive differential until the agency has had an opportunity to more fully evaluate the price/cost profiles of such systems. Thus, the general requirement that a system set its regulated rates at a level equal to the system's September 30, 1992 rate level minus 17 percent (plus certain adjustments) will not apply to regulated cable systems that fall into one of these two categories. The first category consists of systems owned by "small operators," defined as cable operators who have a total subscriber base of 15,000 or fewer customers and who are not affiliated with a larger operator. Systems owned by "small operators" will not be required to reduce rates by 17 percent immediately. Instead, they will be allowed to cap their rates at March 31, 1994 levels until the Commission completes its study of the prices and costs experienced by these small operators. The second category consists of systems that have relatively low prices. "Low-price" systems are defined as (1) those whose March 31, 1994 rates are below the new benchmark, and (2) those whose March 31, 1994 rates are above the revised benchmark but whose full reduction rate is below the benchmark. During the transition period, systems whose March 31, 1994 rates are below the new benchmark will have their rates capped at March 31, 1994 levels. Systems whose March 31, 1994 rates are above the benchmark, but whose full reduction rates are below the benchmark, will only be required to reduce their rates to, and not below, the benchmark. Like small operators, these "low- price" systems will not be required to reduce their rates by the full 17 percent competitive differential unless the Commission's analysis about these operators' prices and costs demonstrates that the revised competitive differential should not be applied to them. To determine whether they are "low-price" systems entitled to transition relief, all systems that do not qualify for transition treatment as "small operators" must compare their March 31, 1994 rates to the new benchmark, and calculate their full reduction rates, using FCC Form 1200. Rate Restructuring A cable system's eligibility for transition treatment does not relieve the system of other Commission requirements concerning the restructuring of equipment and program service offerings. Thus, all regulated systems that have not already restructured their rates and service offerings must do so by (1) setting equipment rates at cost (including a reasonable profit), (2) unbundling equipment charges from programming rates, and (3) applying an average rate per channel when setting program tier charges (so-called "tier-neutrality"). These requirements will not apply, however, to small systems serving 1,000 or fewer subscribers that are eligible for, and elect to follow, a form of administrative relief, described below, which enables them instead to implement a 14 percent line-item reduction for each regulated component that appears on subscribers' bills. (See Administrative Relief for Small Systems). "A La Carte" Packages In its February 22, 1994 decision, the FCC retained its rules concerning the appropriate regulatory treatment of packages of "a la carte" channels, but developed interpretive guidelines to help cable operators and local franchise authorities evaluate in individual cases whether an "a la carte" package should be considered a rate regulated tier. An "a la carte" package will be exempted from rate regulation if two conditions are met: (1) the price of the package is less than the sum of the price of the individual channels, and (2) the offering of channels on an "a la carte" basis presents subscribers with a realistic service offering. In addition, the "a la carte" offering must not evade the Commission's rate regulation. When local franchising authorities and the FCC assess "a la carte" packages, the following factors, if present, will weigh in favor of treating the package as a regulated program tier: the introduction of the package avoids a rate reduction that otherwise would have been required under the Commission's rules; an entire regulated tier has been eliminated and turned into an "a la carte" package; a significant number or percentage of the "a la carte" channels in the package were removed from a regulated service tier; the package price is deeply discounted when compared to the price of an individual channel; and, the subscriber must pay significant equipment or other charges to purchase an individual channel in the package. The following factors will weigh in favor of treating the "a la carte" package as an unregulated offering: the channels in the package have traditionally been offered on an "a la carte" basis; the subscriber is able to select the channels that comprise the "a la carte" package; subscribers are given notice that fully discloses their service options and the total costs (including equipment charges) associated with exercising any of these options; and, the operator has conducted market research that suggests the "a la carte" package would be profitable, other than as a means of evading rate regulation. "A la carte" packages that are found to evade rate regulation rather than enhance subscriber choice will be treated as regulated tiers. Operators engaging in such practices will have to recalculate the rates for all of their regulated program services, since their permitted rate for any one tier depends on the the total number of regulated channels offered by the operator in all tiers. The system also may be subject to forfeitures or other sanctions. Local franchising authorities are allowed to make an initial decision on the regulatory status of an "a la carte" package, or may request a ruling from the Commission as to whether the package is regulated or unregulated. The affected cable operator and its subscribers may challenge the finding at the FCC. The local rate case will stop being processed while the Commission rules on the "a la carte" issue. The Price Cap on Future Rate Increases Future increases in regulated rates are governed by a "price cap" that limits the amount by which cable systems can raise their rates after initial rates have been set. The price cap has two components: annual adjustments for inflation, and up to quarterly adjustments for changes in so-called "external costs," which are narrowly defined and include costs beyond the operator's control. Operators will use FCC Form 1210 to adjust capped rates for inflation and for changes in external costs. Regulated systems must obtain approval from local franchising authorities before increasing their rates for basic service, and must obtain approval from the Commission before increasing the rates for a cable programming services tier if the Commission has found that the tier rates were unreasonable within the last year. Rate Adjustments for Increases in Inflation Cable systems may adjust rates annually for inflation as measured by the Gross National Product Producer Index (GNP-PI) developed by the U.S. Department of Commerce. The inflation adjustment may be made after September 30 of each year, but no later than December 31, and will cover the inflation that occurred from June 30 of the previous year to June 30 of the year in which the inflation adjustment is being made. In the summer of 1994, the Commission's Cable Services Bureau will establish an 800 number that cable systems, local franchising authorities, and subscribers may call to obtain the correct GNP- PI inflation index number for the previous year. The first annual inflation adjustment for all operators will be prorated from the system's initial date of regulation until June 30 of the year of the first annual inflation adjustment. Special adjustments will also be made for systems that restructured rates and service offerings as of September 1, 1993 to comply with the old benchmark system. Operators will be required to use FCC Form 1210 to justify rate increases made to reflect increases in annual inflation. Rate Adjustments for Changes in External Costs Cable systems may adjust rates for regulated services up to quarterly for changes in external costs. "External costs" are defined as: programming costs, retransmission consent fees, taxes on the provision of cable television service, franchise fees, and the costs of meeting franchise requirements. A cable system may adjust its rates for changes in external costs that occurred during the previous calendar quarter as soon as the information needed to compute the appropriate adjustment is available. All changes in a system's external costs (both increases and decreases) must be reflected any time the system adjusts its rates for changes in one external cost or for inflation. Moreover, if there have been no other rate changes during the year, a system must adjust its rates once a year to reflect any decreases that may have occurred in its external costs. A cable system may start accruing external costs for a tier on the date any of its tiers becomes regulated, or on February 28, 1994, whichever occurs earlier. The starting date for accruing retransmission consent fees, however, is October 6, 1994. Rate Adjustments Caused by Adding or Deleting Channels from Regulated Program Tiers The rate adjustments that a cable system can make to reflect changes in the number of regulated channels it offers depend on when the channels are added to (or deleted from) a tier. Channels added to or deleted from regulated tiers between September 30, 1992 and the date of initial regulation (or February 28, 1994, whichever is earlier) are handled through application of the old benchmark methodology using the calculations set forth in FCC Form 393. Channel changes that occur between the date of initial regulation (or February 28, 1994, whichever is earlier) and May 15, 1994 are treated as external costs, since specific rules to govern those changes had not yet been adopted. Channel changes occurring after May 15, 1994 will be handled by a "going-forward" methodology that the Commission adopted on February 22, 1994. Generally speaking, the "going-forward" methodology allows a cable system to increase its rate for a program service tier when it adds one or more channels to that tier. This methodology is also used to calculate how much rates should decrease when a cable system drops a channel from a regulated tier. In essence, a cable system will be able to increase its rates when adding channels by its actual programming costs. The system also will be entitled to recover an additional amount of revenue above and beyond its programming costs. To pass efficiencies along to subscribers, this amount decreases as the number of regulated channels offered by the system increases. The precise calculations for applying the "going-forward" methodology are set forth in FCC Form 1210. Modified Price Cap for Systems Entitled to Transition Relief Systems eligible for transition relief under the revised rules will be subject to a modified price cap pending completion of the Commission's price/cost analysis. Specifically, these systems, like all other regulated systems, will have to compute their full reduction rate. They will also have to calculate their "transition rate," which is simply the rate that they are permitted to charge when they submit FCC Form 1200 to a local or federal regulator. Thus, for systems owned by small operators and systems with below-benchmark rates, their "transition rate" will be their March 31, 1994 rate, as appropriately updated. For systems whose March 31, 1994 rates are above the benchmark, but whose full reduction rates are below the benchmark, their "transition rate" will be the benchmark rate, as appropriately updated. Systems entitled to transition treatment may increase their rates to reflect increases in external costs and increases caused by channel changes that occur after March 31, 1994. These systems may not, however, increase their transition rates to reflect increases in inflation until the transition rate equals their full reduction rate. Under the revised rules, a system's full reduction rate -- which, unlike the transition rate, rises with inflation as well as with changes in external cost and channel changes -- may eventually exceed the transition rate. At the point when the transition rate and the full reduction rate become equal (if such a point occurs during the transition period), the system will be entitled to adjust its rate upward to take advantage of all future inflation adjustments. Administrative Relief for Small Systems In its February 22, 1994 decision, the FCC terminated its stay of rate regulation for cable systems serving 1,000 or fewer subscribers. These small systems will thus become subject to regulation on May 15, 1994. As with larger systems, regulation of the basic service tier will begin once the local franchising authority becomes certified and notifies the cable system that it is regulating basic rates. Regulation of a small system's cable programming services tiers will begin once a complaint about the rates for those tiers is filed with the Commission. Initial notices of regulation and complaints filed before May 15, 1994 will be considered to have been made or filed on May 15, 1994. Regulated small systems will be required to reduce rates to the full reduction level by May 15, 1994 unless they qualify for transition relief as described above. The Commission, however, has established special procedures to reduce the administrative burdens on small systems that are not eligible for transition relief. First, qualifying small systems may implement streamlined rate reductions simply by reducing each item of regulated cable service, including equipment, that appears on subscribers' bills by 14 percent. These systems will not be required to establish unbundled equipment charges based on actual cost until the Commission has developed a schedule of the average equipment costs faced by small systems. A small system may take advantage of these streamlined rate reductions if it either is independently owned, or is owned by an MSO that (1) has 250,000 subscribers or less, (2) owns no system with more than 10,000 subscribers, and (3) has an average system size of 1,000 subscribers. Second, a cable operator of any size may establish unbundled equipment rates for its small systems based on the average equipment costs of those systems. Notifying Subscribers of Rate Changes Cable systems must give their subscribers and franchising authorities at least 30 days written notice before implementing any changes they plan to make in their rates or service offerings. Cable systems must also identify on subscriber bills the precise amount of any rate change and the reason for the change (e.g., inflation, changes in external costs, and changes in channels offered (identified by name)). The notification must also explain subscribers' right to file complaints with the FCC about changes in rates and services for cable programming services. In addition, the system must provide the address and phone number of the local franchising authority and the Commission. Updating Rate Filings Pending Before Local Franchising Authorities or the Commission Many cable systems currently have rate justifications pending before either a local franchising authority or the Commission concerning their initial permitted rate or a rate increase. These cable systems will be required to file FCC Form 1200 with the appropriate regulatory body by June 15, 1994. Some cable systems may have been required to file FCC Form 393, but may not have done so by May 15, 1994. A system asked to file FCC Form 393 by a local franchising authority or the Commission before May 15, 1994 will have until June 15, 1994 to make its filing. The system must at that time file both FCC Form 393 and 1200.