**WRITTEN STATEMENT**

**of**

**KATHLEEN Q. ABERNATHY**

**Commissioner,**

**Federal Communications Commission**

**on**

***The Future of Universal Service***

**Before the\
United States House of Representatives**

**Committee on Energy and Commerce\
Subcommittee on Telecommunications and the Internet**

**Wednesday, September 24, 2003**

**SUMMARY OF STATEMENT OF KATHLEEN Q. ABERNATHY**

The goal of providing high-quality telecommunications services to all
Americans at affordable rates is a cherished principle in U.S.
telecommunications policy and one of the cornerstones of the
Telecommunications Act of 1996. Shortly after Congress's enactment of
the 1996 Act, the FCC adopted rules implementing section 254 to provide
for the collection of explicit universal service support and its
distribution through the high-cost funds and the mechanisms supporting
schools, libraries, rural health clinics, and low-income consumers. Now,
with several years of experience under its belt, the FCC is engaged in a
reexamination of many aspects of the program to ensure that each
component is administered as efficiently and effectively as possible. In
my opinion, to ensure the sustainability of universal service, the FCC
will soon need to revise its rules regarding the collection of funds and
their distribution through the various support mechanisms.

**Contribution Methodology.** Service providers contribute to universal
service based on their revenues from end-user interstate
telecommunications services. In December 2002, the Commission adopted a
number of measures to stabilize the universal service contribution
system and mitigate the growing funding burden on consumers. However, I
believe that more fundamental reform will be necessary to ensure the
sustainability of universal service funding in the long term, because of
the declining trend in interstate revenues and the impact of bundled
service offerings, which increase the difficulty of identifying
interstate revenues and also give carriers the opportunity and incentive
to understate the portion of their revenues that are subject to
assessment. Congress accordingly may wish to consider giving the FCC
authority to assess intrastate revenues ― which would reduce incentives
to game the system ― and the Commission is independently considering
alternatives to its revenue-based contribution methodology to ensure a
stable supply of funding.

**Distribution of Support.** The Commission and the Federal-State Joint
Board also are actively engaged in a review of the rules that govern the
distribution of support to telecommunications carriers. Just as an
insufficient supply of funds could undermine universal service, so too
could runaway demand jeopardize the sustainability of the program. The
most significant demand-side proceeding concerns the intersection of
competition and universal service in areas served by rural telephone
companies. In particular, this rulemaking is focused on the manner in
which competitive providers are designated as eligible
telecommunications carriers and receive funding, and the impact of
designating new ETCs on the growth of the Universal Service Fund. The
Commission also is reconsidering its rules regarding the support
mechanism for "non-rural" carriers in response to a remand by the Court
of Appeals for the Tenth Circuit. This proceeding aims to ensure that
support is sufficient to keep rates affordable and reasonably comparable
in areas served by non-rural carriers.

Taken together, the reforms being considered by the Commission should
ensure the continued vitality of the federal universal service support
mechanisms. The Commission has no higher priority than delivering on the
promise of ubiquitous, high-quality, and affordable services.

**STATEMENT OF COMMISSIONER KATHLEEN Q. ABERNATHY**

Good afternoon, Chairman Upton and distinguished members of the
Subcommittee. I appreciate the opportunity to appear before you to
discuss the challenges confronting universal service and the FCC's
efforts to preserve and advance this critical policy objective.

The goal of providing high-quality telecommunications services to all
Americans at affordable rates is a cherished principle in U.S.
telecommunications policy and one of the cornerstones of the
Telecommunications Act of 1996. I know that every member of this
Subcommittee understands the importance of universal service, and, as
Chair of the Federal-State Board on Universal Service, I make it a top
priority to ensure that the federal support mechanisms fulfill their
objectives.

The 1996 Act directed the FCC to promote two key goals that at times
appear to be in tension with one another: opening local markets to
competition and preserving universal service. The prior monopoly
environment enabled regulators to promote universal service by building
implicit subsidies into local and long distance rate structures. In a
competitive environment, however, these implicit subsidies cannot be
sustained, since the rates that provided surplus funds ― such as
business rates in urban areas ― are undercut by new entrants and
eventually driven down to a cost-based level. Congress accordingly
directed the FCC to adopt explicit support mechanisms that would be
sufficient to ensure that rates remain affordable and reasonably
comparable throughout the nation. In response, the FCC developed several
explicit support mechanisms for carriers that provide service in
high-cost areas. High-cost support will total approximately \$3.3
billion in 2003.

The 1996 Act also expanded the scope of universal service by directing
the Commission to establish support mechanisms for schools and libraries
and for rural health care facilities. The schools and libraries program
(often called the E-Rate program) provides up to \$2.25 billion in
annual support and has enabled millions of school children and library
patrons to gain access to advanced telecommunications and Internet
services. While the rural health program generally has been
underutilized, the FCC is considering a variety of measures to
strengthen it, as discussed below.

In addition to the high-cost support mechanisms and the programs
supporting schools, libraries, and rural health clinics, the FCC's
Lifeline and LinkUp programs provide discounts off monthly service
charges and connection fees to ensure that low-income consumers have
access to basic telephone service. This year, these programs will
provide approximately \$691 million in support.\
All of these programs promote the universal service goals set forth in
section 254(b) of the Act, including the availability of quality
services at affordable rates; access to advanced services in all regions
of the Nation; comparable access to telecommunications services for all
consumers, including low-income consumers and those living in rural,
insular, and other high-cost areas; and access to advanced services for
schools, libraries, and rural health care facilities. Shortly after
Congress's enactment of the 1996 Act, the FCC adopted rules regarding
the collection and distribution of universal service support. Now, with
several years of experience under our belts, we are engaged in a
reexamination of many aspects of the program to ensure that each
component is administered as efficiently and effectively as possible and
that the overall program remains sustainable. A host of marketplace and
technological developments have already prompted some course
corrections, and may ultimately cause us to reassess certain fundamental
policy choices made in the initial implementation period. As we engage
in this review, our commitment to preserving and advancing universal
service remains unwavering.

I describe below some of the challenges confronting universal service
and the efforts the FCC has underway to ensure that each component of
the universal service program remains faithful to the principles set
forth in section 254 of the Act. These proceedings aim to improve and
strengthen all of our support mechanisms, and therefore will benefit
consumers in high-cost areas, families with low income, and patrons of
schools, libraries, and rural health care facilities. In my opinion, the
FCC will soon need to revise its rules regarding the collection of funds
and their distribution through the various support mechanisms. I will
begin with the contribution methodology and then discuss issues
pertaining to the distribution of support.

**Contribution Methodology**

The Commission collects funds for the various universal service support
programs pursuant to section 254(d) of the Communications Act. Service
providers must pay a percentage of their revenues from interstate
end-user telecommunications services to the Universal Service Fund. This
percentage fee, called the contribution factor, changes on a quarterly
basis depending on the demand for funding and the base of reported
revenues. The current contribution factor is 9.5 percent.

Several trends have combined to put upward pressure on the contribution
factor, which in turn has increased the funding burden on some
consumers. While long distance revenues grew between 1984 and 1997, they
have since been flat or in decline as a result of price competition and
substitution of wireless services, e-mail, and, more recently, Voice
Over Internet Protocol (VOIP) services. Because federal universal
service contributions under existing rules are assessed only on
*interstate* revenues from end-user *telecommunications services*, this
shrinking of the applicable revenue base has contributed to a steady
rise in the contribution factor over time ― it has increased by more
than six percentage points over the last six years. While the
contribution factor for the fourth quarter of this year will be 9.2
percent, the slight reduction from the current factor likely represents
a one-time reprieve resulting from an earlier over-collection,
considering that the reported revenue base remains in decline.

Another important trend has been the increasing prevalence of bundled
service plans. For years, wireless carriers have offered buckets of
any-distance minutes at flat rates, and now wireline carriers are
offering packages including local and long distance for a single price.
In addition, many carriers offer business customers bundles that include
local and long distance voice services, Internet access, and customer
premises equipment. Such bundling has been a boon for consumers but has
made it difficult to isolate revenues from interstate telecommunications
services. And the problem is likely to get worse as bundling becomes
more and more popular.

In December 2002, the Commission adopted a number of measures to
stabilize the universal service contribution factor in an effort to
mitigate the growing funding burden on consumers. For example, the
Commission increased from 15% to 28.5% the safe harbor that wireless
carriers may use to determine the interstate percentage of their
revenues. The Commission also eliminated the lag between the reporting
of revenues and the recovery of contribution costs, which lessened the
competitive disadvantages facing long distance carriers with sharply
declining revenues. And the Commission prohibited mark-ups of
contribution costs on customers' bills to ensure that carriers cannot
profit from inflated line charges.

While these were important steps, I believe that more fundamental reform
will be necessary to ensure the sustainability of universal service
funding in the long term. Bundling together interstate and intrastate
services  and telecommunications and information services  gives
carriers the opportunity and incentive to understate the portion of
their revenues that are subject to assessment and increases the
difficulty of identifying interstate revenues. Contribution factors
therefore are likely to continue their ascent under a contribution
methodology based on interstate telecommunications service revenues.

For this reason, the Federal-State Joint Board has recommended that
Congress amend section 254 to provide the FCC with authority to assess
intrastate revenues, in addition to interstate revenues. A total revenue
assessment would be far lower and more stable than one based solely on
interstate revenues, and, just as importantly, it would prevent carriers
from avoiding their contribution obligations by allocating revenues to
the intrastate jurisdiction.

In addition, the Commission has been considering whether to make
substantial changes under its existing statutory authority. The
Commission has sought comment on alternative methodologies based (in
whole or in part) on end-user connections or assigned telephone numbers,
because such approaches arguably would create a more sustainable model
for funding universal service in the future. The number of end-user
connections has been more stable than the pool of interstate revenues,
and connection-based charges can be adjusted based on the capacity of
each connection to ensure an equitable distribution of the funding
burden among business and residential customers. Moreover, proponents of
a contribution methodology based on telephone numbers (with
connection-based charges for high-capacity business lines) argue that it
would not only be more stable but also promote number conservation.
Critics of these proposals ― including carriers that would face
increased assessments based on connections or telephone numbers ― argue
that reducing the contributions of long-distance carriers (which have
very few assigned telephone numbers or end-user connections) would
violate the statutory requirement that all carriers contribute on an
equitable and nondiscriminatory basis.

Finally, the Commission also has sought comment, in the Wireline
Broadband NPRM, on whether all facilities-based providers of broadband
services should be subject to the same contribution obligations. While a
total-revenue methodology or one based on end-user connections or
telephone numbers would address problems arising from the blurring of
the line between interstate and intrastate telecommunications services,
such changes would *not* necessarily broaden the contribution base to
include all broadband transmission services and new services such as
VOIP. The Commission accordingly sought comment on whether or not to
change the contribution pool to include new services that currently are
not assessed. Regardless of whether such services are classified as
telecommunications services or information services, section 254 gives
the FCC permissive authority to assess contributions on
"telecommunications," which underlies both types of services.

#### Distribution of Support

The steady increases in the contribution factor have resulted not only
from the shrinking of the interstate revenue base, but also from the
significant increases in the demand for funding. Much of the increased
demand has resulted from the FCC's reform of interstate access charges:
Many incumbent LECs now recover from the Universal Service Fund costs
that previously were recovered from long distance carriers. In addition,
the increasing entry of wireless carriers and other competitors as
eligible telecommunications carriers (ETCs) has raised questions about
the long-term sustainability of the high-cost support mechanisms. Demand
growth has been less of an issue with respect to the mechanisms that
support schools and libraries, rural health clinics, and low-income
consumers, but I describe below the FCC's recent initiatives to revise
those programs to ensure that they remain efficient and effective.\
**High-Cost Support**

*1. ETC/Portability Issues*

Before enactment of the 1996 Act, only incumbent LECs received universal
service support. In recent years, however, wireless carriers and
competitive LECs have been designated as ETCs. While competitive ETCs
receive a very small percentage of high-cost funds overall, their share
has been increasing dramatically in recent months along with a surge in
the number of ETC applications. Competitive ETCs receive support under
the "identical support" rule (also called "portable support"), which
provides per-line support based on the incumbent ETC's costs. Incumbents
do not lose support when a competitive ETC captures lines; rather, both
carriers receive universal service funding. Rural LECs have argued that
this regime creates uneconomic arbitrage opportunities and threatens the
viability of universal service, while competitive ETCs generally contend
that providing identical support ― whether based on the incumbent LEC's
embedded costs or based on forward-looking economic costs ― is essential
to competitive neutrality.

In November 2002, the Commission asked the Federal-State Joint Board to
consider the intersection of competition and universal service in rural
areas. The Joint Board subsequently sought comment on several key
issues, including the manner in which competitive ETCs receive support
and the impact of providing support to competitive ETCs on the growth of
the universal service fund. The Joint Board also sought comment on the
process for designating ETCs and whether the FCC should establish
guidelines for consideration by the state commissions that make these
determinations under section 214(e)(2). In July, the Joint Board held a
public forum on these issues, and a wide range of industry
representatives, consumer advocates, and state commissioners provided
valuable insights.

Parties advanced a variety of proposals in their comments and at the
public forum. Several groups of incumbent LECs argue that competitive
ETCs should receive support based on their own embedded costs. Some
competitive ETCs argue that incumbents and competitors should receive
support based on forward-looking economic costs. To control growth, some
parties advocate capping support upon entry of a competitor and dividing
the funds pro-rata based on the percentage of lines each carrier serves;
other parties advocate supporting only a single connection per household
(current rules do not limit the number of wireline or wireless
connections that are funded). Incumbent LECs generally oppose these
proposals, arguing that reforming the ETC-designation process ― in
particular, making the public interest analysis more exacting ― would
suffice to keep the Universal Service Fund from growing too large.\
The Joint Board is now considering the record and plans to provide a
recommended decision to the FCC as expeditiously as possible.

*2. Support for Non-Rural Carriers*

While the rural high-cost support mechanism provides the lion's share of
the funding ― and correspondingly has received most of the attention ―
"non-rural" carriers (the Bell operating companies and other relatively
large LECs) also receive high-cost support. Whereas rural carriers
receive support based on their embedded costs, non-rural funding is
determined based on forward-looking economic costs. Non-rural carriers
receive support in a particular state if the statewide average cost per
line, as determined by a computer cost model, exceeds the national
average cost by a certain margin. Currently, non-rural carriers receive
support in eight states (Alabama, Kentucky, Maine, Mississippi, Montana,
Vermont, West Virginia, and Wyoming). While non-rural carriers in other
states serve many high-cost wire centers, their *statewide* *average*
costs are not sufficiently high to receive support. Moreover, rural
carriers receive substantial support in each of the states for which
non-rural support is unavailable.

I understand that this Subcommittee is considering legislation that
would alter the distribution of non-rural support. The Commission is
nearing completion of its own review of this support mechanism in
response to a remand by the Tenth Circuit Court of Appeals. The court
ruled that the Commission did not adequately explain how the non-rural
support mechanism is sufficient to enable states to set affordable rates
that are reasonably comparable in both rural and urban areas. In
addition, the court directed the Commission to consider how to induce
states to develop their own support mechanisms to fund high-cost areas
within their borders, since the federal mechanism aims primarily to
mitigate cost differentials *among* the states. The Joint Board issued
its recommendations last October, and the Commission will complete its
consideration of these issues next month.

**Low-Income Support**

A separate component of the federal universal service program is the
low-income support mechanism, Lifeline/LinkUp. These programs provide
funding that enables low-income consumers to receive discounts on
monthly service and installation charges. An additional layer of
discounts is available for eligible consumers living on Indian tribal
lands. Earlier this year, the Joint Board released a Recommended
Decision on proposals to bolster the effectiveness of Lifeline and
LinkUp. This Recommended Decision suggests new ways for low-income
consumers to qualify for support and also addresses questions regarding
states' efforts to engage in outreach and to verify program eligibility.
The goal of the pending rulemaking is to remove impediments to
beneficiaries' receiving support while simultaneously preserving the
integrity and enhancing the efficiency of the program.

**Schools and Libraries and Rural Health Care Facilities**

Finally, the Schools and Libraries support mechanism (E-Rate) and the
support mechanism for rural health care facilities provide additional
support that enables these institutions to receive discounts on basic
and advanced telecommunications services (as well as internal
connections in the E-Rate program). Now that the Commission has had
significant experience overseeing these programs, we are considering a
variety of rule changes in pending rulemaking proceedings. These
proceedings, like the Lifeline/LinkUp rulemaking, aim to eliminate red
tape while ensuring continued program integrity.

In particular, the Commission will soon consider an Order that would
modify the rural health care mechanism. This support mechanism has been
underutilized, so the notice of proposed rulemaking sought comment on
ways to alter eligibility requirements to eliminate obstacles to rural
health clinics' receiving support, while remaining faithful to the
statutory purposes. Facilitating telemedicine by connecting rural health
clinics to regional hospitals and universities has always been an
important goal, and it takes on added importance in light of the
increased threat of bioterrorism.

\* \* \*

Taken together, the reforms being considered by the Commission should
ensure the continued vitality of the federal universal service support
mechanisms. The Commission has no higher priority than delivering on the
promise of ubiquitous, high-quality, and affordable services. I would
like to thank you, Mr. Chairman, for calling this hearing, and I look
forward to working with you and other members of the Subcommittee on
these challenging and critical issues.