$391-Million Rate Cut by Pac Bell Is Ordered : Utilities: The action marks a new era in regulating the state’s two largest phone firms.

The California Public Utilities Commission ordered Pacific Bell on Monday to cut local phone rates by $391 million a year starting in 1990, saving residential customers about $1.15 a month.

That represents a 4.4% reduction in the average monthly residential bill of $26 and a 6% overall cut in rates for all customers.

While not one of the largest cuts, the reduction nonetheless is a milestone because it marks the start of a new era in regulating Pacific Bell and GTE California, the state’s two largest local phone companies.

The new system--welcomed by the utilities but viewed warily by consumer advocates--creates incentives for phone companies to cut costs by letting them keep most of any savings they can generate by being more efficient.

For customers, the new “incentive-based” system will smooth out rate changes by adjusting prices each New Year’s Day, rather than every three or four years as has been the case for more than 30 years. Customers could also get rebates if phone company profits exceed certain levels but lose some of their power to challenge rates through PUC hearings.

For the utilities, which lobbied hard for the new system, improved efficiency will be rewarded by greater profits. For regulators, the new system will be less costly to administer.

Incentive to Pad Costs

The old system gave companies an incentive to pad costs to increase rates and profits. Under that system, PUC auditors would comb company books and challenge expenditures. Then the commissioners set rates that allowed the phone companies to recover PUC-approved costs, plus earn an authorized profit margin.

The new system pegs rates to provide Pacific Bell and GTE California with an 11.5% profit margin. But they can earn up to 13% without penalty. If they earn more than that, however, the extra profit must be split evenly with customers through rebates. Profits exceeding 16% must be refunded.

The PUC’s order Monday pegged rates so that Pacific Bell will earn an 11.5% profit margin next year.

Each year from now on, rates will be adjusted by applying a formula based on inflation, reduced by 4.5 percentage points to reflect expected decreases in operating costs resulting from labor-saving technology. For example, if inflation is 5%, the annual rate increase will be 0.5%. But if inflation falls below 4.5%, rates will fall.

Monday’s rate reduction will appear as an increase in the present 5.2% credit already applied to Pacific Bell bills to reflect lower costs. The new trim will boost that credit to about 9.8%. Sometime in 1990, the PUC will replace that 9.8% credit with a new list of prices for telephone services.

Audrie Krause, director of the consumer coalition Toward Utility Rate Normalization (TURN), which vigorously opposed scrapping the cost-based regulatory system, said she was surprised by the magnitude of the initial rate cut.

“It’s better than we expected--and certainly better than Pac Bell would have liked,” Krause said.

In response to a PUC order in October, Pacific Bell recommended that its rates be cut by only $239 million.

But Krause predicted that over time, the new formula will favor the utilities’ shareholders over residential customers, resulting in higher prices for consumers than would otherwise have been the case. She noted that the PUC ordered much of the reduction after determining that Pacific Bell was earning more than it was supposed to under current rates.

“The customers were owed this,” she said.

Pacific Bell’s profit margin in 1989 has exceeded 13%, a spokesman acknowledged, resulting in the cut to peg it to an 11.5% return.

GTE California, whose rates were sharply lowered about a year ago, was earning a little less than a 11.5% profit margin, the PUC said. As a result, the commission authorized the Thousand Oaks-based company to increase rates $32 million a year. But it postponed the increase until several pending financial issues are decided.

Yearly Updating

Phone rates will be updated each New Year’s Day by applying a formula that attempts to take into account inflation as measured by the gross national product-price index. But inflation must exceed 4.5% a year before prices can be increased. The PUC said the 4.5% threshold was imposed to challenge the companies to reduce costs.

Pacific Bell serves 9.2 million customers, mostly in California’s urban centers, while GTE California has about 3 million customers, most of them along the southern coast.

Another 20 phone companies that supply local service, mostly in rural areas, are unaffected by the new regulatory system. But the PUC ordered them to pass on to their customers $14.9 million from a special account established by the PUC to subsidize rates in less-populated parts of the state where service costs are higher.

The fund is financed by toll revenues from long-distance phone calls within California.