**FCC 05J-1**

**Released: August 17, 2005**

**FEDERAL-STATE JOINT BOARD ON UNIVERSAL SERVICE SEEKS COMMENT ON
PROPOSALS TO MODIFY THE COMMISSION'S RULES RELATING TO HIGH-COST
UNIVERSAL SERVICE SUPPORT**

**CC Docket No. 96-45**

**Comment Date: September 16, 2005**

**Reply Comment Date: October 3, 2005**

1.  In this Public Notice, the Federal-State Joint Board on Universal
    Service (Joint Board) seeks comment on the attached proposals that
    several Joint Board members and staff have developed. In August
    2004, the Joint Board sought comment on issues referred to it by the
    Commission related to universal service for rural carriers and the
    basis of support for competitive eligible telecommunications
    carriers.[^1] Several individual Joint Board members and staff
    members have recently proposed solutions for addressing these
    issues. These proposals are appended to this Public Notice.[^2] We
    ask that interested parties provide comment regarding how each
    proposal addresses the goals of the Act, the Commission's universal
    service goals, and any other criteria or issues described in the
    August 2004 Public Notice. Commenters are also invited to supplement
    the record with respect to any additional issues or facts that have
    been raised since the comment period for the August 2004 Public
    Notice closed.

2.  Pursuant to sections 1.415 and 1.419 of the Commission's rules, 47
    CFR §§ 1.415, 1.419, interested parties may file comments and reply
    comments on or before the dates indicated on the first page of this
    document. Comments may be filed using: (1) the Commission's
    Electronic Comment Filing System (ECFS), (2) the Federal
    Government's eRulemaking Portal, or (3) by filing paper copies. *See
    Electronic Filing of Documents in Rulemaking Proceedings*, 63 FR
    24121 (1998).

-   Electronic Filers: Comments may be filed electronically using the
    Internet by accessing the ECFS: <http://www.fcc.gov/cgb/ecfs/> or
    the Federal eRulemaking Portal:
    [http://www.regulations.gov](http://www.regulations.gov/). Filers
    should follow the instructions provided on the website for
    submitting comments.

    -   For ECFS filers, if multiple docket or rulemaking numbers appear
        in the caption of this proceeding, filers must transmit one
        electronic copy of the comments for each docket or rulemaking
        number referenced in the caption. In completing the transmittal
        screen, filers should include their full name, U.S. Postal
        Service mailing address, and the applicable docket or rulemaking
        number. Parties may also submit an electronic comment by
        Internet e-mail. To get filing instructions, filers should send
        an e-mail to <ecfs@fcc.gov>, and include the following words in
        the body of the message, "get form." A sample form and
        directions will be sent in response.

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-   Paper Filers: Parties who choose to file by paper must file an
    original and four copies of each filing. If more than one docket or
    rulemaking number appears in the caption of this proceeding, filers
    must submit two additional copies for each additional docket or
    rulemaking number.

> Filings can be sent by hand or messenger delivery, by commercial
> overnight courier, or by first-class or overnight U.S. Postal Service
> mail (although we continue to experience delays in receiving U.S.
> Postal Service mail). All filings must be addressed to the
> Commission's Secretary, Office of the Secretary, Federal
> Communications Commission.

-   The Commission's contractor will receive hand-delivered or
    messenger-delivered paper filings for the Commission's Secretary at
    236 Massachusetts Avenue, NE., Suite 110, Washington, DC 20002. The
    filing hours at this location are 8:00 a.m. to 7:00 p.m. All hand
    deliveries must be held together with rubber bands or fasteners. Any
    envelopes must be disposed of [before]{.underline} entering the
    building.

-   Commercial overnight mail (other than U.S. Postal Service Express
    Mail and Priority Mail) must be sent to 9300 East Hampton Drive,
    Capitol Heights, MD 20743.

-   U.S. Postal Service first-class, Express, and Priority mail should
    be addressed to 445 12^th^ Street, SW, Washington DC 20554.

People with Disabilities: To request materials in accessible formats for
people with disabilities (braille, large print, electronic files, audio
format), send an e-mail to <fcc504@fcc.gov> or call the Consumer &
Governmental Affairs Bureau at 202-418-0530 (voice), 202-418-0432 (tty).

3.  In addition, one copy of each pleading must be sent to each of the
    following:

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(1) The Commission's duplicating contractor, Best Copy and Printing,
    Inc, 445 12^th^ Street, S.W., Room CY-B402, Washington, D.C. 20554;
    website: [www.bcpiweb.com](http://www.bcpiweb.com/); phone:
    1-800-378-3160;

(2) Sheryl Todd, Telecommunications Access Policy Division, Wireline
    Competition Bureau, 445 12^th^ Street, S.W., Room 5-B540,
    Washington, D.C. 20554; e-mail: sheryl.todd@fcc.gov.

**APPENDIX A**

**The State Allocation Mechanism**

**A Universal Service Reform Package**

**Proposed by Joint Board Member Ray Baum**

This package proposes a six step transition over four years to a State
Allocation Mechanism ("SAM") for the distribution of Federal Universal
Service High Cost and Lifeline/Linkup Funds. Before describing the
transition, however, it is useful to describe the permanent plan, which
would be in effect beginning in June of 2009.

##  {#section .unnumbered}

## The SAM

Beginning in June of 2009, the FCC would make allocations of Federal
Universal Service High Cost and Lifeline/Linkup Funds to accounts for
each State maintained by the Universal Service Administrative Company
("USAC").

Each State commission would be allowed to determine the distribution of
its allocation to Eligible Telecommunications Carriers ("ETCs") in its
State. State distributions to ETCs would be subject to FCC guidelines
and review to ensure compliance with §254 of the Communications Act. The
FCC would act in the place of any State that did not perform this role
or is found to be out of compliance with the FCC guidelines.

Participating States would also have responsibility for ongoing
oversight to ensure accountability for the use of Universal Service
funds.

USAC would remain as the administrator of the Universal Service funds.
Fund contributions would still be made to USAC and disbursements would
be made by USAC directly to ETCs, pursuant to the distribution decisions
made by State commissions.

A participating State would be allowed to support its own additional
universal service efforts by adopting an increment to the Federal
funding mechanism applicable only to consumers in its State, with the
proceeds accruing to the State's account at USAC.[^3] The distribution
of these funds would not be subject to FCC guidelines and review.

###  {#section-1 .unnumbered}

### The Allocation Method

The method for allocation of Federal Universal Service funds to the
State accounts at USAC would be established by the FCC. The method could
be based on factors such as:

1.  the results of a cost model of either embedded or forward-looking
    costs for the most efficient technology;

2.  a rate benchmark designed to meet the affordability and reasonable
    comparability requirements of §254, described in more detail below;

3.  the intercarrier compensation reform plan adopted by the FCC; and

4.  the number of consumers in the State that are eligible for Lifeline
    and Linkup support based on federal criteria.

It is sometimes assumed that cost models are necessarily based on
forward-looking economic cost ("FLEC"), but this is incorrect. It is no
more difficult, and arguably easier, to construct an embedded cost model
than a FLEC model. As an example, average schedules have long been used
in the telephone industry for a variety of intercompany compensation
purposes. Use of a cost model to determine cost allocations to the
States is therefore independent of the decision as to whether to use
FLEC or embedded costs. Many of the advantages of models occur whether
the cost model is based on FLEC or embedded costs, such as the
maintenance of incentives for efficiency, ease of administration, etc.

All models involve error, even if they are correct on average.
Experience with the current FCC FLEC model suggests that it involves
relatively large errors for particular wire centers. This is not a
problem when the model is applied to a carrier with a large number of
wire centers, but, when the model is applied to carriers with few wire
centers, the errors become a more serious problem.

Applying a model on a statewide basis is a good way to manage
unavoidable error. The errors will tend to cancel out across the wire
centers in each State. Further, with only fifty model results instead of
more than a thousand, the FCC would be in a position to review carefully
the model results and make adjustments if necessary. In some cases,
Alaska being a prominent example, the model is unlikely to reflect
unique cost drivers such as roadless areas and permafrost.

Although not generally recognized, embedded costs, either based on a
model or the actual embedded costs of each carrier, also involve error,
i.e., they can overstate or understate the actual need for universal
service support in particular cases. That is one reason why it is
important that States be in a position to make adjustments to each ETC's
allocation based on a case-by-case analysis no matter what the
allocation methodology employed.

If the FCC determines that it does not want to use a cost model, the SAM
allocation could be accomplished using alternative methods, including
consideration of historical funding levels, carrier specific embedded
costs, or other criteria.

A criteria for any universal service program is whether or not it is
efficient, i.e. whether maximum consumer benefit is produced for the
funds expended. Under the SAM approach, States would have large
incentives to maximize consumer welfare by using their allocations in
the most efficient way. Every dollar given to one ETC would be a dollar
that could not be given to another.

###  {#section-2 .unnumbered}

### The Rate Benchmark

A rate benchmark should be used to meet the statutory objectives for
affordability and reasonable comparability established by Congress in
§254 of the Communications Act. The rate benchmark could be used by the
FCC in making the State allocations. It would establish an expectation
that local consumers would be responsible for the costs of the local
network serving them up to a level at which the price of supported
services would not be affordable or reasonably comparable, as required
by §254.

The level of the rate benchmark would be periodically adjusted, based on
consideration of a number of factors, such as:

1.  the amount of and eligibility criteria for Lifeline/Linkup support;

2.  data on the penetration of supported services;

3.  economic and demographic data relating to affordability, such as
    household income, cost of living, etc.

This last factor requires some explanation. Affordability varies across
States based on economic and demographic factors such as household
income and cost of living. The benchmark would be established for each
state based on these factors.

An example may help to illustrate the use of a rate benchmark. Suppose,
for discussion, that the FCC chooses an embedded cost model patterned on
average schedules. This average schedule would estimate the embedded
cost of the local network. The rate benchmark for the State would be
multiplied by subscriber counts for the State to determine an expected
amount of subscriber revenue for the State. This amount would be
deducted from the average schedule embedded cost. The net amount of
support would be credited to the State's account at USAC.

###  {#section-3 .unnumbered}

### Jurisdictional Issues

These State allocations and the rate benchmark would be
non-jurisdictional, and hence would not rely on the jurisdictional
separation of revenues, plant, or expenses. All revenues, including
subscriber line charges and comparable mandatory charges would be
included in the rate benchmark and all costs would be included in the
cost model.

###  {#section-4 .unnumbered}

### FCC Guidelines and Review

In order to comply with the requirements of §254 and to ensure that
national policy is properly implemented, the FCC must retain the
authority to establish guidelines and to review State programs for
compliance with the statute and the guidelines. These guidelines and the
review process would be established as part of an implementation
rulemaking initiated subsequent to the adoption of this package.

An example serves to illustrate the nature of the guidelines that might
be adopted. Concern has been expressed by some ETCs that the SAM
mechanism is not "specific, predictable, and sufficient," one of the
principles established in §254(b). The FCC might decide that it would
make the State allocations every five years, for example. The State's
allocation would therefore be specific, predictable, and, presumably,
sufficient. The guidelines might require that the States make an
allocation to each ETC for the same period, conditioned on compliance
with commitments made as a condition of receiving funding. ETCs that
felt their allocation was not specific, predictable, and sufficient
could make their case to the FCC in the context of the latter's review
of the State's plan. States would be permitted to conduct annual
compliance reviews and to withdraw or reduce funding if the ETC was not
living up to its commitments.

##  {#section-5 .unnumbered}

## The Transition

As everyone recognizes, universal service and intercarrier compensation
reform are inextricably linked. The transition will be described on the
assumption that a currently unknown intercarrier compensation reform
plan is adopted before the end of the transition.

The timeline below describes a transition including six steps over four
years, with the SAM mechanism taking effect in June of 2009.

**Timeline for Transition to SAM Mechanism**

+-----+--------------+------------------------------------------------+
| **  | **Date**     | **Action**                                     |
| Ste |              |                                                |
| p** |              |                                                |
+-----+--------------+------------------------------------------------+
| St  | December     | Joint Board issues Recommended Decision        |
| ep1 | 2005         |                                                |
+-----+--------------+------------------------------------------------+
| S   | June 2006    | FCC issues decisions on intercarrier           |
| tep |              | compensation and universal service, including  |
| 2   |              | for offsets of intercarrier compensation       |
|     |              | losses from USF;                               |
|     |              |                                                |
|     |              | Universal service distributions frozen at 2Q   |
|     |              | 2006 levels.                                   |
|     |              |                                                |
|     |              | FCC makes referral to Universal Service Joint  |
|     |              | Board to determine SAM guidelines,             |
|     |              | specification of the benchmark and amount of   |
|     |              | 2009-2014 SAM allocations to States;           |
|     |              |                                                |
|     |              | Joint Board issues data request to USAC        |
+-----+--------------+------------------------------------------------+
| S   | December     | Joint Board issues Recommended Decision        |
| tep | 2006         |                                                |
| 3   |              |                                                |
+-----+--------------+------------------------------------------------+
| S   | June 2007    | First step of intercarrier compensation offset |
| tep |              | implemented; FCC issues guidelines for State   |
| 4   |              | plans and SAM distributions;                   |
|     |              |                                                |
|     |              | FCC establishes benchmark and initial          |
|     |              | 2009-2014 SAM allocations;                     |
+-----+--------------+------------------------------------------------+
| S   | June 2008    | Second step of intercarrier compensation       |
| tep |              | offset implemented;                            |
| 5   |              |                                                |
|     |              | 2009-2014 State plans and proposed SAM         |
|     |              | distributions to FCC for review, including     |
|     |              | State increment to collection mechanism, if    |
|     |              | any;                                           |
|     |              |                                                |
|     |              | FCC commences rulemakings to act in place of   |
|     |              | States that do not submit plans                |
+-----+--------------+------------------------------------------------+
| S   | June 2009    | First SAM distributions to ETCs;               |
| tep |              |                                                |
| 6   |              | State increment for collection goes into       |
|     |              | effect;                                        |
|     |              |                                                |
|     |              | Third step of intercarrier compensation offset |
|     |              | implemented in conjunction with first SAM      |
|     |              | distribution                                   |
+-----+--------------+------------------------------------------------+
|     |              |                                                |
+-----+--------------+------------------------------------------------+

The purpose of the transition is to:

1.  phase-in the impacts of intercarrier compensation reform and the
    rate benchmark;

2.  allow for considered and timely adoption of implementation plans by
    the Joint Board and the FCC; and,

3.  provide time for the States to prepare their universal service plans
    and for the FCC to review them.

For planning purposes, an assumption was made that the Joint Board will
issue its Recommended Decision in December of 2005 and that the FCC will
issue its decisions on intercarrier compensation and universal service
in June of 2006.

All ETC distributions could be frozen for an interim period at the level
of those distributions in the second quarter of 2006. This would avoid
growth in the fund.[^4] To this base amount of universal service
support, offsets could be added for intercarrier compensation losses, as
determined by the FCC in its intercarrier compensation order. For
illustrative purposes here, it is assumed that the FCC specifies phased
offsets in June of 2007-2009. Any offsets taking effect subsequent to
the implementation of the SAM could be incorporated into the State
allocations.

At the time that the FCC acts on the Joint Board's initial Recommended
Decision, it should make a subsequent referral for consideration of
implementation issues. The Joint Board would be given six months to make
a further Recommended Decision describing the FCC's guidelines for
review of State plans and the level of the initial SAM allocations. To
accomplish this task, the Joint Board would be empowered to issue a data
request to USAC, which would coordinate the collection of data from all
ETCs. In this draft timeline, it is assumed that the initial SAM
allocations would be for a period of five years.

In June of 2007, the FCC would issue its guidelines for review of State
plans and it would also establish the initial five year SAM allocations
for the States. States would have one year to prepare their plans and
submit them to the FCC. The FCC would then have one year to review them
and to act in the place of States that did not submit plans.

The first SAM allocations and distributions would be made as of June
2009.

**APPENDIX B**

**Three Stage Package for**

**Universal Service Reform**

**Proposed by Joint Board Member Billy Jack Gregg**

Universal Service deserves a fresh look in light of recent
technological, market, regulatory and judicial developments. However,
the Joint Board also needs to respond in a timely manner to the current
FCC referral of rural support issues. Accordingly, the following package
of Universal Service reforms contains three stages: one short-term stage
which makes various changes to rationalize and simplify existing rural
support mechanisms; a second mid-term stage which modifies the manner in
which support is determined for rural carriers; and a third long-term
stage which attempts to provide a unified approach to Universal Service.

Stage one of this package can be accomplished within the context of the
current Joint Board referral; that is, the Joint Board can act on these
proposals based on the currently noticed referral and record developed
to date. Stages two and three would require new proceedings and comments
in order to properly develop a record for reforming the federal
high-cost support mechanism. As such, stages two and three are broad
roadmaps for future action by the FCC and Joint Board in that the
details will be developed at a later date. It should be noted that this
package does not assume any particular reform of intercarrier
compensation, but can accommodate a wide range of changes to the current
intercarrier compensation regime.

**STAGE ONE -- Short-Term Plan**

This stage would have five parts which would reform the existing support
system under the current referral to the Joint Board:

1\. **Combine Study Areas.** All study areas within a state owned by a
single company would be combined into one study area for universal
service purposes. This rule would apply to all carriers, rural and
non-rural. Consolidation would occur five years after acquisition of
additional study area(s), or two years after adoption of the new rule
requiring consolidation, whichever is later. After consolidation,
high-cost support would be based on cost data for the entire combined
study area.

2\. **Move Large Carriers to the Model**. All rural carriers serving
100,000 lines or more within a state would have support determined
pursuant to the Commission's High Cost Model, just as it is for
non-rural carriers. However, rural carriers moved to the model should
not be subject to "statewide averaging" of costs currently used in the
non-rural support mechanism.[^5] Support for large rural carriers moved
to the model would be based on the costs of that individual carrier's
operations within a single state.

3\. **Freeze Per Line Support upon Competitive Entry**. For those rural
study areas remaining on embedded cost support, freeze per line support
for the incumbent upon entry of a competitive ETC.

4\. **Determine Support Based on Each ETC's Own Costs**. For those rural
study areas remaining on embedded cost support, base per line support on
each ETC's own costs, capped at per line support of the incumbent.

5\. **Extend Rate Comparability Review to Rural Carriers**. In the
*Tenth Circuit Remand Order*[^6] the FCC required states to review rates
in rural areas served by non-rural carriers and certify that they were
at or below the rate comparability benchmark. States with rates above
the benchmark could petition for supplemental rate support. Even though
the level of the rate benchmark has been remanded to the FCC for further
review,[^7] rural customers of rural carriers should have the same
protection against excessive rates as enjoyed by customers of non-rural
carriers.

**End Result of Stage One**

1\. Combination of study areas within a state under common ownership
would result in recognition of efficiencies of scale and scope actually
enjoyed by each carrier. Consideration of a carrier's entire operations
will ensure that local switching support goes only to truly small
carriers that cannot obtain such efficiencies, and should reduce the
total amount of local switching support. On the other hand, this
proposal would remove a barrier to sale and acquisition of rural
exchanges by allowing recovery of costs associated with acquired rural
exchanges after five years (or two years of adoption of rule). In other
words, the "parent trap" established by 47 C.F.R. §54.305 would be
eliminated. Because of their unique characteristics, Alaska and insular
areas should be exempted from this requirement to combine study areas.

2\. Use of the model for larger carriers should reduce the total amount
of high cost support and eliminate problems with determining per line
support for individual wire centers. This proposal would affect 37 rural
study areas serving 10.4 million access lines. (If all study areas owned
by a single company within a state are combined as proposed in point 1,
an additional 57 rural study areas serving 1.6 million access lines
would also be affected.) Rural carriers with study areas serving less
than 100,000 lines would continue to have support determined using the
modified embedded method. In other words, 94 rural study areas serving
12 million access lines (an average of 127,659 access lines per study
area) would be moved to the model, while 1,255 rural study areas serving
9.5 million access lines (an average of 7,570 access lines per study
area) would remain on the current modified embedded methodology of
determining costs. Because of their unique characteristics, Alaska and
insular areas would also be exempted from this requirement. In other
words, large rural carriers in these areas would continue to use the
current modified embedded cost methodology.

3\. Freezing per line support upon competitive entry in study areas
served by smaller carriers (less than 100,000 lines) would prevent per
line support determined under the modified embedded cost methodology
from spiraling to unreasonable levels as a result of lines lost to
competitors.[^8] Frozen per line support would grow at rural growth
factor as recommended by the Rural Task Force in 2000.

4\. Basing embedded cost support on each carrier's own costs would
prevent potential windfalls to competitive ETCs with lower cost
structures than incumbents. Capping support would prevent competitive
ETCs from reaping unreasonable per line support on an embedded basis
simply because they serve few lines.

5\. Extension of rate comparability review to rural carriers would
ensure that all rural customers are protected against unreasonably high
rates, regardless of changes in universal service funding and
intercarrier compensation.

Adoption of the proposals contained in Stage One would stabilize the
fund over the next three to five years, but allow carriers to
rationalize their service areas and business plans. Combination of study
areas under common ownership would eliminate switching support for some
carriers, but would allow loop support to be based on actual investments
made throughout a carrier's service area, including newly acquired study
areas. Although the Stage One proposals would eliminate potential
support windfalls to CETCs which exist under the modified embedded
support system, the proposals would not address the problem of
ever-increasing support for CETCs caused by supporting multiple lines of
multiple ETCs within the same high-cost area.

**STAGE TWO- Mid-Term Plan**

Under this proposal, support for rural carriers remaining on the
modified embedded cost methodology would be based on the total costs of
these carriers, and would also consider the revenues received, including
intercarrier revenues. As a result, the support mechanism resulting from
Stage Two could accommodate whatever changes to intercarrier
compensation are ultimately adopted.

1\. **Base Support on Total Costs of Rural Carriers**. Currently, the
three separate rural support mechanisms -- High Cost Loop, Local
Switching Support, and Interstate Common Line Support -- look at
different aspects of the costs of rural companies, but do not consider
transport costs. In addition, rural carriers with high switching costs
serving over 50,000 lines are not eligible for support. Stage Two would
adopt a unified approach to support for rural carriers remaining on the
modified embedded method, and would provide support for all types of
costs incurred in providing supported services: loop, switching and
transport. This portion of the Stage Two proposal is almost exactly the
same as proposed in Section II.B. of the Universal Service Endpoint
Reform Plan ("USERP").[^9] If the definition of supported services is
expanded to include broadband, costs related to broadband could be added
to the calculation.

2\. **Compare Embedded Costs of Rural Carriers to Available Revenues**.
The current federal support mechanisms for both rural and non-rural
carriers are based on cost benchmarks.[^10] However, as originally
conceived, federal support was to be based on a comparison of costs to a
revenue benchmark.[^11] Under a revenue benchmark approach, the costs of
a particular carrier are compared to revenues available to support those
costs. If costs exceed revenues, then a certain portion of the excess
costs are eligible for federal support. The unseparated costs of each
rural carrier -- determined as set forth in point 1 above -- should be
compared to the unseparated intercarrier revenues (interstate and
intrastate) received by each carrier plus a national revenue
benchmark.[^12] The national revenue benchmark would represent the local
contribution to support of carrier costs expected of all local customers
throughout the nation.

As an example of how this primary support[^13] mechanism would work,
refer to Carrier A and Carrier B previously cited in footnote 6. Once
again, assume that each carrier has unseparated costs of \$46 per line
per month. Also assume that Carrier A has monthly intercarrier revenues
of \$11 per line and local revenues of \$32 per line, and Carrier B has
intercarrier revenues of \$16 per line and local revenues of \$16 per
line. Finally, assume that the national revenue benchmark is \$30 per
line per month. Carrier A's costs are \$46 per line, minus \$11 in
intercarrier revenue and \$30 in national revenue benchmark, leaving an
excess of costs over revenues of \$5 per line per month. Carrier B's
costs are \$46 per line, minus \$16 per line in intercarrier revenue and
\$30 in national revenue benchmark, leaving no excess of cost over
revenue. If the federal USF support is based on 76% of excess costs,
Carrier A would receive \$3.80 per line per month in support (\$5.00 X
76%), while Carrier B would receive no support.

If intercarrier compensation reform is adopted and intercarrier revenues
decline, primary support levels would also change under this mechanism.
Using all of the same assumptions for Carriers A and B stated above, but
assuming that intercarrier revenue for both carriers drops to \$2 per
line, both carriers would receive \$10.64 per line in federal universal
service support.[^14] Once again, the level of primary support would not
be affected by the local rates actually charged by either Carrier A or
Carrier B.[^15]

3\. **Federal Support Should Be Based on a Percentage of Excess Costs**.
If carrier costs are compared to available revenues, the amount of
primary support should be based on a percentage of the costs in excess
of revenues. This is consistent with current support mechanisms for both
rural and non-rural carriers. Primary federal support should not be 100%
compensatory for excess costs in order to provide an incentive for
efficiency, and to provide a role for state universal service funds in
achieving comparable rates.

**End Result of Stage Two**

1\. Use of total costs of rural carriers remaining on the modified
embedded support methodology would more appropriately direct support to
carriers with high costs in the aggregate, not merely those carriers
that are small in size. A unified approach would also include
consideration of transport costs which are extremely high for some rural
carriers.

2\. Use of revenue benchmarks would take into consideration the level of
intercarrier compensation actually received by each carrier, and would
address the issue of the minimum revenue contribution expected from
local customers. As a result of using a national revenue benchmark,
rather than the actual local revenues of each carrier in determining
support, Carrier A is not penalized because it has high local rates, and
Carrier B is not benefited because it has low rates. Furthermore, there
is no requirement that Carrier B increase its local rates in order to
receive support.[^16] On the other hand, if reforms in intercarrier
compensation result in a reduction in intercarrier compensation actually
received by Carriers A and B, they may both be eligible for additional
federal USF support as intercarrier revenues decline. The revenue
benchmark proposal doesn't presume any particular change to the
intercarrier compensation regime, but can accommodate any changes
actually implemented.

3\. The percentage of excess costs eligible for federal support can be
modified to achieve an overall level of support that is consistent with
Section 254 of the Act and that is consistent with the end-result
desired by policymakers. The percentage of support provided could be
varied depending on the size of the carrier involved, or the relative
size of excess costs, as under the current system. In other words, the
percentage of support provided could increase as the line size of the
study area served decreased, or as the amount of excess costs increased.

**STAGE THREE- Long-Term Plan**

Following completion of intercarrier compensation reform, the support
system outlined in Stage Two above would transition into a unified
system, based on allocations of support to the states. This proposal
would encourage a fresh look at Section 254 and the requirement to
preserve and advance universal service, with no preconceptions
concerning maintenance of the current system.

1\. **Unified System**. This proposal would seek to develop a unified
system to support high-cost areas regardless of status of the serving
carrier. Differences in treatment between rural and non-rural carriers,
between incumbents and new entrants, and between technologies should be
eliminated.

2\. **Allocation and Distribution of Support**. This proposal
contemplates a "block grant" system similar to the plan proposed in the
"State Allocation Mechanism" (SAM) or in Section II.A. of the USERP
plan. Federal support would be allocated to states, and states would be
responsible for distributing funds to ETCs serving high-cost areas
within their borders. Distribution of funds would be based on guidelines
established by the FCC to meet the universal service goals of Section
254.

3\. **Limitations on Growth in Fund**. The amount of the block grants
would be adjusted annually for changes in the GDP-CPI index. After five
years, the level of federal support would be reviewed and adjusted as
necessary.

**End Result of Stage Three**

1\. This long term plan would initially limit the growth in the size of
the fund to growth in inflation. Future changes in the size of the fund
could be considered by the FCC in a holistic manner.

2\. Moving to the state grant system would stabilize the size of fund,
but difficult decisions on allocating funds to different carriers and
areas within each state would be transferred to state commissions.
Operating within federal guidelines, states should be in a better
position to know where funds are needed most.

3\. States that designate multiple ETCs within the same high-cost area
would have to deal with how to pay for those decisions, and still
maintain comparable rates.

**APPENDIX C**

**A HOLISTICALLY INTEGRATED PACKAGE**

**Submitted by Commissioner Robert Nelson to**

**Federal-State Joint Board on Universal Service**

The package proposed herein responds to the issues in the Commission's
referral to the Joint Board (CC Docket No. 96-45). It contains elements
of the various packages previously submitted by Board members ( Billy
Jack Gregg and Commissioner Baum) as well as elements from the Universal
Service Endpoint Reform Plan (USERP) submitted by Staff members Bluhm,
Shiffman and Parsley. In addition, it relies heavily on the Intercarrier
Compensation proposal submitted as part of the record by the NARUC Task
Force chaired by Commissioner Elliott Smith. Although it may be argued
that some of the elements of this package are beyond the scope of the
referral, the package attempts to keep within the parameters of the
referral and addresses each of the issues presented in the Options Memo
circulated by Staff on April 13, 2005. As such it attempts to integrate
the various elements of the options memo into a holistic proposal.

**I. BLOCK GRANTS/ STATE ALLOCATION MECHANISM**

Although the issue of block grants is the last of the issues outlined in
the Options Memo, it is critical to the resolution of other issues
presented in the Options Memo. Block grants have been advanced as a
possible alternative to the current distribution methodology for the
High Cost Fund, as long ago as April, 2000 (See "Cooperative Federalism:
The State Perspective", Inaugural Telecommunications Policy and Law
Syposium, Michigan State University Detroit College of Law). Although
"block grants" is the term used in the Options memo, the NARUC
Intercarrier Compensation Proposal (NICP) contains a similar concept,
the State Allocation Mechanism, which more closely comports with Section
254 of the Federal Telecommunications Act (FTA) than a true block grant.
That concept is adopted in the Holistically Integrated Package (HIP).

The State Allocation Mechanism (SAM) would be administered pursuant to
FCC guidelines and with continuing FCC oversight and would therefore not
be an impermissible delegation of authority. Moreover, it embodies the
spirit of cooperative federalism that is the hallmark of Section 254, as
recently reaffirmed by the 10^th^ Circuit in [Qwest II,]{.underline} 258
F. 3^rd^ at 1203. Under the HIP proposal, the FCC's guidelines would
address both how to determine what each state receives for the SAM, and,
in general, how each state would allocate its disbursements within the
state. Unlike certain packages however, the HIP would leave the states
with more discretion to distribute the funds in accordance with the
guidelines. For example, State A could distribute SAM funds to ETCs, in
accordance with FCC guidelines, but may determine that more than one
carrier could be funded in a given rural area, while State B could
determine that only one carrier could be funded in a similar rural area.
Additionally, if a state wanted to extend the transition period for
certain small carriers (e.g., less than 5,000 access lines), it could do
so. This discretion is consistent with Section 102(2) of the FTA, with
regard to ETC designation and rural exemptions. The FCC guidelines would
spell out the factors a state could consider in making its distributions
(embedded costs, forward looking costs, Lifeline/Linkup participation)
but each state would determine the amount each carrier receives,
provided that the permanent rate benchmark proposed in the NICP (125% of
the national urban rate) is honored.

Like certain other packages, the HIP proposes that the SAM would take
effect after a three year transition period. During the transition
period, rural carriers would be held harmless and receive at least as
much high cost support as they did during 2004 provided that states
certify that the fund is being used for the purposes intended. The
states would have authority, during the transition period, to find that
a given carrier should receive less high cost support than what
historical levels provided, if the carrier's earnings levels were
unreasonably high or if service quality deteriorated below acceptable
levels. In addition, the states, with the Commission's review, could
adopt a "best practices" benchmark, as proposed by Dr.Selwyn, to further
control the size of the fund. The HIP proposal is more consistent with
the NICP than is the USERP, which provides for a decrease in hold
harmless funding in years two and three of \$1 per switched line.
Although this provision of the USERP is designed to avoid rate shock,
other means to achieve this objective (capping SLC increases, etc.)
could be used.

States are in a better position to ensure that USF funds are distributed
to where they are needed because they are close to the customers and can
provide the day-to-day oversight that is necessary to monitor potential
abuse. Moreover, it is vitally important to provide a predictable
support mechanism for carriers. Higher cost and potentially risky
infrastructure investment will not take place at appropriate levels if
carriers cannot predict with a level of certainty just which investments
will be supported through USF money. Rural companies are especially
vulnerable, facing risks unlike their urban counterparts. Rural carriers
face unique construction/networking challenges with a lower subscription
population and a lower price change tolerance, leaving them less margin
for financial error. States need the flexibility to address the unique
circumstances of rural carriers.

**II. DEFINITION OF RURAL CARRIER**

The HIP adopts the principle advanced by the NICP that support for high
cost rural areas should not be based on whether that area is served by a
"rural" or "non-rural" carrier. Accordingly, the issue of how to define
a rural carrier, after the transition period, becomes moot because all
carriers serving rural areas would be eligible for support.

During the transition period, support would be provided in accordance
with the hold harmless provisions detailed above (Section I). For those
states that opt-out of the SAM, there would be continued reliance on the
existing definition of rural carrier.

**III. COST BASIS OF SUPPORT AND CALUCLATION OF SUPPORT**

The FCC referral includes a request to consider whether having support
for rural carriers based on statewide average costs is more consistent
with Section 254 of the Federal Telecommunications Act than the current
study area approach. (Par. 44) In the options memo prepared by Staff,
the issue of the use of statewide average costs for rural carriers for
determining support is presented (Section III, Issue 2, Option 2). Since
the HIP adopts the principles that states should be given discretion to
allocate USF funds and support should be based on the characteristic of
the study area and not the carrier, the combination of study areas is a
logical extension of these principles. The USERP makes a compelling case
for calculating the high cost support amounts based upon the aggregated
characteristics of all carriers in a state as well as combining all
existing high cost support (loop, switching, safety net, etc.) into one
program. Although it has been argued that combining study areas will
make support "less explicit", the advocates of that position seem to
assume that the Commission will continue to use the existing
distribution formula for the HCF. However, the adoption of the SAM, with
the limitations provided for in the HIP, will allow states to ensure
that support is provided where it is needed. Eventually, the use of
statewide average costs can provide an incentive for investment in rural
facilities. During the transition, reliance on study areas for
calculation of support can continue , enabling rural carriers to provide
the level of service they have provided in the past.

Combining study areas and existing programs in a holistic manner allows
each state to better control the growth in the total USF. The package
proposed by Billy Jack Gregg assumes that adopting a unified approach in
this way may be outside the scope of the referral, but it is a concept
that is incorporated in Stage Two of his plan. The referral, by asking
broadly about the use of statewide average costs (Para. 44) and the need
to merge various components of the high cost fund (Par. 47),
specifically permits the adoption of the USERP proposals. If issues of
statewide averaging and merging of component parts of the high cost fund
are not considered in this referral, they may not be revisited by the
Joint Board for many years.

**IV. SUPPORT FOR TRANSFERRED EXCHANGES**

The referral specifically asks whether Section 54.305 of the
Commission's rules should be retained, modified or repealed. In keeping
with the holistic and integrated nature of the HIP, Section 54.305,
which provides limits on high cost funding available to an acquiring
carrier based on the historical level of support provided prior to the
acquisition. Since the HIP proposes that the distinction between rural
and non-rural carriers be eliminated (See II, above), compliance with
Section 54.305 would not be necessary. Accordingly, it should be
repealed. If acquisitions occur during the transition period, the
provision of safety valve support should be continued through the
duration of the period.

**V. CONTRIBUTION METHODOLOGY**

Although the referral does not specifically address the contribution
methodology for the USF, the NICP does. It provides for expansion of
contributions through the use of a connections, bandwidth or numbers
based approach (Section II. #3). The HIP includes such a recommendation.
It is imperative that, regardless of the scope of the referral, that all
carriers that utilize the public switched telephone network be required
to contribute to the USF as soon as possible. The dramatic decrease in
traditional long distance wireline traffic and the increase in the use
of VoIP and the deployment of IP networks has changed the dynamics of
USF so irrevocably that immediate attention to the issue is required .
Consideration of the expansion of contributions is necessary to continue
to provide the support contemplated in the rest of the HIP

**SUMMARY**

The Commission's referral seeks comment on whether to reform the rural
HCF support mechanism. The mechanism cannot be viewed in a vacuum. The
time has come to consider the integration of the rural HCF, the
non-rural fund, the impact of intercarrier compensation and contribution
methodology holistically. By recommending a package like HIP, including
a SAM, the Joint Board can allow states, pursuant to FCC guidelines, to
control the USF while continuing to provide support to areas where it is
most needed.

**APPENDIX D**

# Package on Universal Service Reform  {#package-on-universal-service-reform .Document-Heading}

# "Universal Service Endpoint Reform Plan" (USERP) {#universal-service-endpoint-reform-plan-userp .Document-Heading}

Proposed by Joel Shifman, Peter Bluhm and Jeff Pursley

# Overview {#overview .unnumbered}

This plan has two main components. The first addresses support for
wireline Incumbent Local Exchange Carriers ("ILECs"), principally by
increasing reliance on state commissions to achieve the goals set forth
in section 254. The second component proposes a new method for
allocating universal service funds to competitive Eligible
Telecommunications Carriers ("ETCs").

# Funding for Wireline in High-Cost Areas {#funding-for-wireline-in-high-cost-areas .unnumbered}

## The State Allocation Mechanism {#the-state-allocation-mechanism .unnumbered}

USAC would still calculate support amounts to incumbent local exchange
carriers and would continue to disburse funds to carriers; but the state
commission in each state would determine allocations to carriers within
that state. State commissions would have what amounts to a power of
appointment (or allocation) over federal high-cost funds. States would
also be responsible for ensuring that wireline carriers receive
sufficient support so that the rates in all wirecenters do not exceed a
benchmark amount. States would also determine the purposes to which
funds are applied.

The plan anticipates that support to carriers would come from a mix of
state and federal universal service funds. While this plan creates
incentives for states to create their own universal service funds and
raise rates to a federal benchmark, it does not require states to do so.
States may face more pressure to increase explicit support in some areas
where competition is making continued rate averaging impracticable.

This role for state commissions is consistent with the Act. The Act gave
states significant responsibility to act as partners with the FCC in
achieving national universal service goals. State commissions would
retain all current jurisdiction (if any) over local exchange rates. For
this reason, the plan assigns primary responsibility for universal
service to the agency that has the most oversight over end-user rates,
and states would be primarily responsible for rate differences within
their boundaries.[^17] Federal support ("Part I") would be provided
where average costs are so high that the state cannot attain comparable
and affordable rates through its own efforts. A second form of federal
support ("Part II") would be provided where a state needs to make
extraordinarily large efforts to equalize the differences within its own
boundaries.

The following sections discuss how costs would be measured under the
plan, how the FCC would allocate support totals to the states, and how
the states would sub-allocate that support to carriers.

## Costs {#costs .unnumbered}

The plan would be primarily cost-based, although costs would be adjusted
for intercarrier revenues. To determine costs, the plan would look
generally at "embedded" or accounting cost,[^18] and would calculate
what amounts to a revenue requirement for plant, depreciation, return
and operations. This choice should maintain current incentives for
continued network investment.[^19]

Nevertheless, costs would be limited in ways that reduce incentives for
wasteful spending. This could be done with the cost outputs of a
"forward-looking" costs model[^20] or with "best in class"
standards.[^21] Limitations would be imposed in cost or investment areas
where abuse is suspected and where imposing the cap would not unduly
harm investment incentives.

The plan would look comprehensively at all categories of ILEC costs,
including loop, ports, switching and transport.[^22] Costs would also
include all operations, including network operations, customer service
operations, and corporate operations. Costs will be considered on an
aggregate basis; and a low cost in one category will offset a high cost
in another category.

This contrasts with current support programs. For rural carriers,
current programs look only at specific cost components, such as
switching[^23] or loops, and they do not include any costs for tandem
switching or interoffice transport.[^24] For nonrural carriers, the
Model Based Support Program includes loop costs, plus some local
switching and local transport costs. It does not include the costs of
all local and tandem switching nor all transport costs.[^25]

The plan also provides support for costs in both jurisdictions using a
unified approach. Therefore, it replaces not only programs now
supporting intrastate costs, but also programs such as IAS and ICLS that
support interstate costs.

## Federal Support To States {#federal-support-to-states .unnumbered}

Federal support to each state might come in two forms, as described
below.

### Part I Support {#part-i-support .unnumbered}

Federal "Part I" support is designed to continue the FCC's policy of
maintaining affordable and comparable rates among states. Support would
be calculated based upon the aggregated cost characteristics of all
incumbent carriers in the state and provided to states with high average
costs. This would effectively assign states the principal responsibility
for universal service support within their own borders.

This averaging policy is consistent with that used now for nonrural
carriers (although it does not use a forward-looking cost model). It
would be a change, however, for rural carriers, whose support is now
separately calculated for "study areas" without any regard for costs
elsewhere in the same state.

Section 254 speaks to "rates." The plan would equate rates with the
average unit revenue requirement that a carrier must recover from its
customers ("Consumer Cost"). The plan assumes this is equal to the
difference between the carrier's total cost and it inter-carrier
revenues.[^26] To manage customer rates, federal support therefore would
manage the carrier's "Consumer Cost."[^27]

The plan would set a benchmark standard to ensure that Consumer Cost is
affordable and reasonably comparable. A "permanent benchmark" would be
set at 125 percent of the national average urban cost (net of
intercarrier revenue).[^28] Support to each state would be sufficient to
keep this cost at or below the benchmark everywhere in that state.[^29]
This provides a functional definition of "affordable" and "reasonably
comparable" rates. The effect would be that, after federal support has
been received, average Consumer Cost would be, in every state, no higher
than the benchmark.[^30]

Except during a transitional period, the plan does not provide more
support than is necessary to achieve affordability and comparability.
Specifically, no state should have so much federal support that it could
set some rates (which reflect Consumer Cost) below the benchmark and
still have enough federal support to keep other rates from rising above
the benchmark.[^31]

### Part II Support {#part-ii-support .unnumbered}

The second support program recognizes that state USF charges are
themselves a part of "rates," and that state USF programs can impose
significant burdens on urban ratepayers, in violation of the principles
of section 254. Part II support would be provided to states in which an
explicit high-cost fund would impose an undue internal burden on state
ratepayers, but only to states that actually have explicit USF programs.

Because states with substantial rural areas would have the greatest
burden of support, Part II support would be available in those states
with the highest proportions of high-cost customers. Part II support
would be calculated without any direct reference to the state's average
cost, and would be available without regard to whether the state also
received Part I support. Any Part I support, however, would offset Part
II support.

To calculate the internal burden imposed by a state USF program, Part II
support would make standardized assumptions about state USF effort. It
would assume that the state has been divided into three zones,
corresponding to the UNE zones existing in most states. These zones are
customarily called "urban," "suburban," and "rural."[^32] The plan also
assumes that the state provides support to customers in each zone based
on the average cost in that zone and using a uniform benchmark that is
equal to the benchmark used for Part I support. Imputed state support to
each zone is then calculated and summed. The required contribution level
of state telecommunications customers is then calculated. If that
required contribution level exceeds \$2.00 per month, [^33] then Part II
support would make up any difference not already covered by Part I
support.[^34]

### Hold Harmless and Separations {#hold-harmless-and-separations .unnumbered}

Transition to the new plan would be gradual through use of a declining
hold-harmless mechanism. In the first year, hold-harmless support would
equal the support received by the state in the previous year. Each year
thereafter, hold-harmless support to the state would decrease by \$1.00
per month per switched line until the hold-harmless provision no longer
had any effect. This provision allows the state commission to transfer
federal support gradually to more needy areas and to implement state USF
funds (where necessary), but without creating a risk of rate shock.

The plan is "omni-jurisdictional" because it does not rely on
traditional separated costs. First, the new program would replace all
existing universal service programs, regardless of the nature of the
costs they currently support. Specifically, the plan would replace High
Cost Loop Support, Local Switching Support, Safety Net Support, High
Cost Model Support, Interstate Access Support, and Interstate Common
Line Support. Second, the support calculation would consider costs on a
total or "unseparated" basis.[^35] Third, the plan is indifferent to the
jurisdiction of revenue. For intercarrier revenue in particular, the
plan is not concerned about whether that revenue is derived from
intrastate or interstate traffic.[^36]

## State Allocations of Support {#state-allocations-of-support .unnumbered}

States would have first-line responsibility to ensure that all customers
have rates that are affordable and comparable. In many cases, federal
support and retail rate averaging would be sufficient to achieve this
goal. In other cases, explicit state universal service programs would be
needed. The following four cases illustrate how state and federal funds
would interact.[^37]

-   Case 1: Uniform low cost. This state would not receive any Part I or
    Part II federal support. Since Consumer Cost is already below the
    benchmark, universal service objectives can be achieved without any
    federal or state USF programs.

-   Case 2: Uniform high cost. The plan would provide Part I support so
    that, if it is well distributed to all carriers, each carrier would
    have an average Consumer Cost below the benchmark and each customer
    would have a rate that is affordable and comparable.

-   Case 3: High but varying cost everywhere. This case is more
    probable. Federal Part I support would still come to the state,
    since its average cost is high. Compared to Case 2, however, the
    allocation task for the state commission is more complex, and
    different carriers will be allocated different amounts of federal
    support. The end result, however, is the same as Case 2: each
    carrier would have an average Consumer Cost below the benchmark and
    each customer would have a rate that is affordable and comparable.

-   4: Some high cost, some low cost. This is the most probable case.
    Because some customers have low cost, Part I support would not be
    sufficient to produce everywhere a Consumer Cost below the
    benchmark. Instead, the state would need to establish a state
    universal service fund under section 254(f).[^38] That state program
    would impose a charge in all areas, including low-cost areas. The
    charge would raise effective rates everywhere, but the support it
    produces would reduce costs in high-cost areas. If the imputed state
    USF charge rises above \$2.00 per month, Part II support would also
    be provided to the state.[^39]

In all four cases the final results should be the same: average Consumer
Cost for each carrier would be below the benchmark, and each customer
would have an opportunity for a rate that is affordable and comparable.

State distribution decisions would be subject to some limitations.
First, distributions should be sufficient to ensure that rates can be
just, affordable and -- because they are no higher than the permanent
benchmark -- reasonably comparable to urban areas nationwide. Second,
support to an ILEC would not depend on whether the ILEC is classified as
a "rural telephone company." Third, distributions should be predictable
and should be based on published data and explicit and predetermined
calculations.

Fourth, state distributions to carriers would be constrained by
declining hold-harmless protection. Each year, hold-harmless support to
any carrier might decrease by \$1.00 per month per switched line. This
would allow the state commission to transfer federal support gradually
to more needy areas and to implement state USF funds (where necessary)
while minimizing rate shock.

Except for these four limitations, state allocations would be
discretionary. States could assign support to particular carriers, study
areas or exchanges. They could also condition support funds on
particular uses, such as requiring the carrier to meet broadband
deployment targets in particular exchanges. Each state would annually
notify USAC and the FCC of its allocation plan.

State commissions would be required to file annual reports with the FCC,
concurrent with the annual ETC certifications now filed in September.
The reports would allocate support for the upcoming year to ETCs. The
reports would also include:

-   A section 254 compliance report, including the results of rate
    comparability surveys, conducted according to a prescribed method,
    and including an evaluation of the success of state and federal
    programs in achieving affordable and reasonably comparable local
    exchange rates.

-   An accountability summary explaining how federal funds have been and
    are likely to be used by carriers to promote universal service,
    including the results of any company audits or "agreed-upon
    procedure" reviews that the state requires from ETCs.

-   A broadband report describing the state' broadband deployment goals
    and summarizing progress toward those goals.

Any carrier or customer may petition the FCC to review whether a state's
support allocation decisions have been sufficient to produce affordable
and comparable rates.

## Rural and Nonrural {#rural-and-nonrural .unnumbered}

The plan would apply to all companies, rural and nonrural.[^40] This
would be an effective means to address issues raised in *Qwest II* and
would eliminate the present pattern that rates and support can depend on
the type of carrier that owns an exchange, rather than on whether that
exchange is rural or high-cost. This would also eliminate the so-called
"parent trap" problem under which support levels are controlled by the
history of which exchanges were controlled at particular times by which
kinds of carriers.

The plan could conceivably be applied solely to rural companies.[^41]
That choice, however, has disadvantages. Most important, it would treat
rural areas differently based upon the identity of the carrier that
serves it. This choice would also leave unresolved the sufficiency of
federal support to non-rural carriers, a matter that must be addressed
following *Qwest II.*

## Non-Participating States and the Federal Overlay {#non-participating-states-and-the-federal-overlay .unnumbered}

Some states have low average Consumer Costs, but also have some very
high-cost areas. Implicit intra-company transfers are currently large
enough in most of these states to prevent unaffordable or non-comparable
rates. Some low or moderate cost states, though, will need to adopt
supplemental state universal service programs. The act does not require
that any state adopt a subsection 254(f) programs, and the FCC probably
cannot mandate such state programs under existing law, even if the Joint
Board and the FCC think they would be useful. As a result, some states
might not do enough, in the judgment of the Joint Board, to meet their
responsibilities under section 254. The Act does not clearly provide a
judicial remedy to individual customers in this circumstance. The FCC
may have to provide a remedy since it is the FCC that has ultimate
responsibility for compliance with section 254.

One option would be for the FCC to operate what amounts to a
state-specific universal service program in those states that do not
establish a state program on their own. This would require the FCC to
establish a supplemental universal service charge that applies only in
one state. Revenues from this supplemental charge, together with any
support otherwise due to the state, would then be allocated directly by
the FCC to carriers. In these cases, the state would not exercise its
normal role in establishing state programs and in allocating federal
support.

In states with such a federal overlay, all customers would pay a higher
total federal USF charge higher than is paid by customers in other
states. However, because the additional proceeds would defray costs in
high-cost areas, the net effect should be that all customers in the
state have affordable and comparable rates.

# Competitive ETCs {#competitive-etcs .unnumbered}

The plan would restructure support to Competitive ETCs, making the most
significant changes with regard to wireless CETCs.

The current universal service fund provides portable support to CETCs
based on ILEC support. It also increases per-line support to ILECs as
they lose customers. This can have the overall effect of financing
competitive CETC networks with universal service.[^42] The plan does not
fully address that problem, which is rooted in the portability rules.
Although the suggestions below should slow the growth of the fund's CETC
payments, more fundamental policy changes would be needed to fully
insure the universal service fund against growth of this kind.

## Wireless CETCs  {#wireless-cetcs .unnumbered}

Wireless CETCs would no longer be funded by "portable" universal service
support that is based on the costs of incumbent wireline carriers. This
policy change reflects the fundamental cost, regulatory and rate
differences between wireless and wireline service. There are also
functional differences that limit substitution of one service for the
other.

Wireless and wireline networks have different cost characteristics.
First, the geographic scales are different. For wireline networks, costs
are largely determined at the wireline exchange or "wire center" level,
and those costs control USF support. By contrast, wireless costs are
primarily incurred over areas served by antenna towers, which can be
larger or smaller than wire centers. Second, building density is the
most significant cost driver for wireline networks. Wireless networks
also serve travelers, particularly along highways, allowing for cost
recovery from customers who live elsewhere. Third, wireless services are
not subject to the same regulatory requirements as wireline companies.
Equal access, service quality standards, tariffing, and regulatory
reporting requirements all add cost to wireline operations. Providing
support to wireless carriers based on wireline costs creates
opportunities for financial windfalls.

Wireless rates also operate at a different geographic scale. For most
wireless carriers, rates do not vary locally or even across state lines.
Further, wireless rates and rate structures differ from traditional
wireline. As a result, using common benchmarks for both wireline and
wireless services may not accomplish the goals of universal service.
While universal service support to wireless carriers may create
incentives for these carriers to expand their coverage to unserved
areas, that support is unlikely to have an effect on the affordability
or comparability of wireless rates.

Wireless services can perform functions not possible for wireline
service. Nevertheless, most customers do not yet consider wireless to be
a full substitute. Although the substitution rate is increasing, most
customers still consider wireless to be a different service that
supplements their landline service. The effect of providing universal
service to wireless under these circumstances therefore is to support
construction of a second, parallel network.

Under the plan, wireless CETCs would instead be funded through a
separate "Portability Fund" that would be available only to wireless
carriers. The goal of the fund would be to substantially improve
wireless coverage in unserved areas, with a particular emphasis on
unserved areas with major roads.[^43]

The Portability Fund would be capped at \$1 billion per year. This is
more than the projected \$800 million CETC support projected for 2005,
but substantially less than the approximately \$1.8 billion that the
wireless industry contributes to USF.

The Portability Fund would extend for five years and would then sunset.
As the sunset date approaches, the Joint Board would review the program
and assess whether the Portability Fund should be extended for an
additional term.

As with wireline support, the first step in administering the
Portability Fund would be to allocate money to the states. Federal
allocations would be made based on a combination of factors including
the size of unserved low-density areas, public safety needs and the
probable call volumes from incrementally serving new areas.

State commissions would then sub-allocate their funds to CMRS carriers
using a competitive grant method. State commissions would request
proposals from CMRS carriers to provide additional coverage in unserved
areas and unserved roads.[^44] The state commission would then award
federal grants for construction of additional facilities. The grantee
would be required to show thereafter that all funds had actually been
properly expended.

## Other Competitive ETCs {#other-competitive-etcs .unnumbered}

The plan would continue the present portability policy for wireline
CETCs of basing support on ILEC costs, but the scale of measurement
would change. Under the plan, each incumbent's costs would be
disaggregated below the wire center level. Each rural wire center would
have two or more disaggregation zones, at least one devoted to the city,
village or town center. In rural areas, a "rural doughnut" surrounding
this core would also be defined; and it ordinarily would have higher
costs and be entitled to higher support.[^45] To simplify the support
calculation, several rural "doughnut" zones could be aggregated into a
single rural class.

The plan would also require some changes to UNE pricing. UNE prices
would be deaveraged using the same disaggregation zones that are used
for determining support to CETCS.

[^1]: *Federal-State Joint Board Seeks Comment on Certain of the
    Commission's Rules Relating to High-Cost Universal Service Support*,
    Public Notice, CC Docket No. 96-45, FCC 04J-2, (rel. Aug. 16, 2004)
    (August 2004 Public Notice). Specifically, the Joint Board sought
    comment on three main issues: (1) whether the Commission should
    adopt a universal service support mechanism for rural carriers based
    on forward-looking economic cost estimates or embedded costs; (2)
    whether the Commission should amend the \"rural telephone company\"
    definition for high-cost universal service support to consider
    consolidating multiple study areas within a state; and (3) whether
    the Commission should retain or modify section 54.305 of its rules
    regarding the amount of universal service support for transferred
    exchanges. *Id.*

[^2]: "The State Allocation Mechanism: A Universal Service Reform
    Package", proposed by Joint Board Member Ray Baum, attached as
    Appendix A; "Three Stage Package for Universal Service Reform",
    proposed by Joint Board Member Billy Jack Gregg, attached as
    Appendix B; "A Holistically Integrated Package", proposed by
    Commissioner Robert Nelson, attached as Appendix C; "Universal
    Service Endpoint Reform Plan (USERP)", proposed by Joel Shifman,
    Peter Bluhm and Jeff Pursley, attached as Appendix D.

[^3]: This provision would take effect if and when the FCC shifts from
    an interstate revenues contribution base to a non-jurisdictional
    contribution base such as telephone numbers or connections.

[^4]: As an alternative, rural and non-rural companies could calculate
    their Federal Universal Service Fund entitlement using existing
    procedures, i.e., both the rural and the non-rural mechanisms could
    remain in effect for the transition period. Intercarrier
    compensation offset amounts would be added to these amounts.

[^5]: Under the current non-rural support mechanism, the forward-looking
    costs of each non-rural carrier within a state are first determined
    by the model. The total costs of all non-rural carriers are then
    added together and divided by the total number of lines served by
    non-rural carriers within that state. See, 47 C.F.R. §54.309(a). If
    the statewide average costs are below the cost benchmark for
    non-rural carriers, then no non-rural carriers in that state receive
    high-cost model support. This is true even if individual carriers
    have per line costs above the cost benchmark. In essence, the higher
    costs of smaller carriers are often lost in the averaging with
    larger low-cost carriers within the same state. Under the proposal
    in point 2 above, larger rural carriers moved to the model would
    continue to have their support determined on an individual basis. In
    other words, the costs of these larger rural carriers would not be
    averaged in with the costs of other carriers within the state using
    the model.

[^6]: *In re: Federal-State Joint Board on Universal Service*, CC Docket
    No. 96-45, Order on Remand, Further Notice of Proposed Rulemaking,
    and Memorandum Opinion and Order, 18 FCC Rcd 22559 (2003) ("*Tenth
    Circuit Remand Order*").

[^7]: *Qwest Communications International, Inc. v. FCC*, 398 F.3d 1222
    (10^th^ Cir. 2005) ("*Qwest II*").

[^8]: This problem was addressed at pages 20-21 of the Rural Task
    Force's White Paper No. 5 (Sept. 2000). Although a rural incumbent
    may lose access lines as a result of competitive entry of another
    ETC, it is not likely that the incumbent's total costs and, thus,
    total support under the modified embedded cost methodology would
    decline. As a result, per line support for the incumbent would
    increase as the number of lines decreases. If support for CETCs
    continues to be based on the per line support available to the
    incumbent, then per line support for the CETC would also rise as it
    takes lines from the incumbent, leading to a spiraling effect.

[^9]: The USERP Plan was submitted to the FCC on July 28, 2005.

[^10]: Under the current cost benchmark, two different rural carriers of
    similar size -- Carrier A and Carrier B -- with costs of \$46 per
    line per month -- would receive the same amount of federal support.
    This would be true regardless of the level of local rates and
    regardless of the amount of intercarrier compensation received by
    the two carriers. Use of a revenue benchmark could result in
    different levels of support for these two carriers based on the
    amount of revenues each receives.

[^11]: See, *In re: Federal-State Joint Board on Universal Service*, CC
    Docket No. 96-45, First Report and Order, 12 FCC Rcd 8776 (1997) at
    ¶¶257-267. Several states also consider revenues in providing
    support under state USFs.

[^12]: The national revenue benchmark should encompass all revenues
    except intercarrier revenues.

[^13]: The term "primary support" is used to differentiate support
    determined by comparing costs to revenues from supplemental rate
    support determined by comparing local rates to the national rate
    comparability benchmark. See point 5 in Stage One.

[^14]: Unseparated costs of \$46 per line minus national revenue
    benchmark of \$30 per line minus intercarrier revenue of \$2 per
    line equals excess costs of \$14 per line for both Carrier A and
    Carrier B. Multiplying the \$14 per line excess cost by 76% equals
    support of \$10.64 per line.

[^15]: As discussed in point 5 of Stage One, carriers would, however,
    have recourse to supplemental rate support if local rates exceeded
    the rate comparability benchmark.

[^16]: This proposal does not assume any change in local rate
    regulation. The ability of any carrier to change local rates would
    be a matter for the individual carrier and the appropriate
    regulatory authority. The appropriate use of USF funds received
    would also continue to be a matter for the appropriate regulatory
    authority pursuant to Section 254(e) of the Act.

[^17]: Additional federal responsibility in this area is an option
    explained below.

[^18]: As noted below, for certain purposes, where existing records are
    not sufficient to allocate costs to areas smaller than study areas,
    overall costs could be allocated among wire centers using
    forward-looking cost models.

[^19]: While the plan would use embedded cost as the primary inputs for
    support calculations, the support mechanism described below would
    also work if the Commission were to use forward-looking costs.

[^20]: For example, feeder and loop investment, and switching
    investment, could be limited to 125% of the output of a
    forward-looking model. Exceptions might be needed in areas where the
    model is not likely to take account of all cost factors, such as in
    permafrost areas or areas not served by the general road network.

[^21]: For example, corporate operations expenses are currently capped
    for the High Cost Loop Program based upon industry average costs. A
    revised cap of this sort might impose stricter limits based upon a
    class of low-overhead companies. Dr. Lee Selwyn suggested this
    approach at the Joint Board's hearing on Universal Service on June
    7, 2005.

[^22]: Incremental costs of vertical services would be excluded.

[^23]: Although local switching costs are supported by the Local
    Switching Support Program, that support is not determined on the
    aggregate level of those costs, but upon study area size, which does
    not always predict switching cost.

[^24]: Since this plan provides universal service support for high
    transport and tandem switching costs, it reduces the burdens on NECA
    pools and intercarrier compensation recovery. This may simplify the
    task for intercarrier compensation reformers.

[^25]: Some of these excluded costs are recovered through intercarrier
    compensation and, for some companies, the NECA pooling process.

[^26]: Billing and collection revenues would be treated as intercarrier
    revenues.

[^27]: The equation expressing this is:

    *Consumer Cost = Gross Cost -- Net Intercarrier Revenue -- Universal
    Service.*

    Gross Cost would be determined as described in the preceding
    section, and might exclude some plant or expenses associated with
    unregulated services.

[^28]: This benchmark is significantly lower than that rejected by the
    Tenth Circuit in *Qwest II.* In that case the court rejected a
    *rate*-based standard of 138% of the national urban *rate.* However,
    the FCC had used a *cost*-based benchmark of two standard deviations
    to actually distribute support. Neither the court nor the FCC made
    findings about how this cost benchmark related, as a percentage, to
    either national average cost or to urban average cost. The court did
    find, however, that the FCC had not demonstrated that there was any
    record support for its "pairing of rates to costs."

    As noted in the main text, the plan sets a standard of 125% of urban
    average cost, net of intercarrier revenue. In the third quarter of
    2005, USAC is using a cost-based benchmark (\$28.13) equal to 131%
    of the national average cost (\$21.43). For two reasons these
    percentages cannot be directly compared:

    The 131% is a multiple of *average* cost, but the 125% is a multiple
    of *urban* cost. The FCC has never made any finding about urban
    average cost, so it is not possible to convert the one standard to
    the other without additional findings.

    The existing mechanisms are not adjusted for inter-carrier revenues.

[^29]: Support would be equal to the following, with all terms defined
    on a per-line, per-month basis:

    *Federal Support to State = State Average Cost -- Net Intercarrier
    Revenue -- Permanent Benchmark*

[^30]: As discussed in the following sections, internal cost variations
    within a state would be a matter primarily of concern to that state.

[^31]: As discussed below, any state with low rates and costs in some
    areas might need to have a state universal service fund under
    subsection 254(f) to avoid violating section 254.

[^32]: By aligning the boundaries of UNE zones with USF calculations,
    opportunities for arbitrage can be eliminated.

[^33]: Wireline and wireless lines would both be counted. This
    calculation does not presume that the state would actually collect
    revenue on a per-line basis.

[^34]: An illustrative calculation of Part II support is attached in
    spreadsheet form.

[^35]: This is true today for the High Cost Loop and High Cost Model
    Support programs.

[^36]: Separations would formally continue, but as is true today with
    "Average Schedule" companies, jurisdictional separations would be
    determined by the jurisdictional nature of revenues. For example, if
    30% of revenues are interstate, a total company separations
    methodology would assign 30% of costs to interstate.

[^37]: In the examples, "low cost" means a Consumer Cost below the
    benchmark, and "high cost" means a Consumer Cost above the
    benchmark.

[^38]: We discuss below an optional mechanism to use when the state
    fails to take this action.

[^39]: Where a state cannot implement a state universal service program
    (such as because of a lack of state law authority), the FCC may have
    to substitute for the state and operate this portion of the program
    directly.

[^40]: This choice might exceed the scope of the current referral to the
    Joint Board.

[^41]: This would leave in place some existing universal service
    programs that apply to nonrural carriers, including the High Cost
    Model Program and Interstate Access Support.

[^42]: For example, consider a rural ILEC whose territory has been
    overbuilt by a neighboring CLEC. As the competitor gains lines, the
    rural ILEC's overall support would not ordinarily decrease, because
    its loop and switching costs would not decrease. Rather, the ILEC's
    total support would remain relatively constant despite a shrinking
    customer base, and its per-customer support would increase. Under
    the portability rule, this would increase per-line support for the
    CLEC. In the simplified case where the carriers equally divide the
    market and each has the same per-line cost, the net effect could be
    that universal service support would not change for the ILEC but
    would pay all or nearly all the cost of constructing the CLEC's
    overbuild. If the CLEC should obtain more than a 50% market share,
    universal service could pay more than the total cost of the CLEC's
    network.

[^43]: Roads through designated wilderness areas might be excluded from
    eligibility.

[^44]: If it appears that relatively few areas and roads are unserved,
    the commission could identify areas with service from only one CMRS
    carrier and use the funds to establish a second provider's signal.

[^45]: By the time this plan can be implemented, one or more states may
    have already filed disaggregation plans based upon sub-wire-center
    disaggregation. In those states, no new disaggregation plan would be
    needed.