The Communications Act of 1934 sets forth the nation’s telecommunications policy, including making communication services available “so far as possible, to all the people of the United States.” Early efforts by FCC, state regulators, and industry to promote universal service generally began in the 1950s. At that time, increasing amounts of the costs associated with providing local telephone service were recovered from rates for long-distance services. This had the effect of lowering local telephone rates and raising long-distance rates, which was intended to make local telephone service more affordable. Because American Telephone and Telegraph Company (AT&T) provided both nationwide long-distance service and local telephone service to approximately 80 percent of the nation’s telephone subscribers, universal service was largely promoted by shifting costs between different customers and services. Following the divestiture of AT&T’s local telephone companies in 1984, FCC made several changes to universal service policy. First, the costs associated with local telephone service could no longer be shifted internally within AT&T. FCC therefore implemented access charges—fees that long-distance companies pay to originate and terminate long-distance telephone calls over the local telephone network. Access charges were intended to not only recover the cost of originating and terminating long- distance telephone calls over the local telephone networks, but also to subsidize local telephone service. Second, FCC initiated several federal efforts that targeted support to low-income customers to bring the rates for basic telephone service within their reach. At this time, federal universal service was for the most part funded through charges imposed on long-distance companies. The Congress made significant changes to universal service policy through the 1996 Act. First, the 1996 Act provided explicit statutory support for federal universal service policy. Second, the 1996 Act extended the scope of federal universal service—beyond the traditional focus on low-income consumers and consumers in rural and high-cost areas—to include eligible schools, libraries, and rural health care providers. Third, the 1996 Act altered the federal mechanism for funding universal service. Every telecommunications carrier, and other entities, providing interstate telecommunications services were required to contribute to federal universal service, unless exempted by FCC; and their contributions were to be equitable, nondiscriminatory, and explicit. Contributions are deposited into the federal Universal Service Fund (USF), from which disbursements are made for the various federal universal service programs. Fourth, the 1996 Act established a Federal-State Joint Board on Universal Service (Joint Board). This Joint Board, which is composed of three FCC commissioners, four state regulatory commissioners, and a consumer advocate, makes recommendations to FCC on implementing the universal service-related provisions of the 1996 Act. The USF provides support through four different programs, each targeting a particular group of telecommunications users (see table 1). In 2007, support for the four USF programs totaled $7 billion. Among the four programs, the high-cost program accounted for the largest amount of support—$4.3 billion or 62 percent of USF support. The high-cost program provides financial support to carriers operating in high-cost—generally rural—areas in order to offset their costs, thereby allowing these carriers to provide rates and services that are comparable to the rates and services that customers in low-cost—generally urban—areas receive. Both federal and state governments play a role in implementing the federal high-cost program. FCC has overall responsibility for the federal high-cost program, including making and interpreting policy, overseeing the operations of the program, and ensuring compliance with its rules. However, FCC delegated to USAC responsibility to administer the day-to- day operations of the high-cost program. USAC is a not-for-profit corporation and a subsidiary of NECA, although NECA does not participate in the management of USAC. NECA, a not-for-profit association of local telephone carriers and the primary administrator of FCC’s access charge plan, collects cost and line count data from its members and validates this information. At the state level, state regulatory commissions hold the primary responsibility to determine carrier eligibility for participation in the program and to annually certify that carriers will appropriately use high-cost program support. Table 2 summarizes the general roles and responsibilities of the agencies and organizations involved in high-cost program administration. To be eligible to receive high-cost program support, a carrier must be designated as an eligible telecommunications carrier (ETC). Section 214(e)(1) of the 1996 Act requires that to be designated an ETC, the carrier must (1) offer the services that FCC identified as eligible for universal service support throughout the service area for which the designation is received, (2) advertise the availability of those services, and (3) use at least some of its own facilities to deliver those services. There are two types of carriers. Incumbents. When the Congress passed the 1996 Act, existing telephone carriers that were members of NECA were designated as incumbent carriers for their service areas. These incumbents subsequently received ETC status. These incumbents are further classified as either “rural”— generally small carriers serving primarily rural areas—or “nonrural”— generally large carriers serving both rural and urban areas. Competitors. Carriers competing against incumbents—both wireline and wireless—also are eligible to receive high-cost program support. Just like incumbents, these companies must apply for eligibility and receive ETC status before they can receive support; these carriers are referred to as competitive eligible telecommunications carriers (CETC). Competitors can provide service without receiving CETC status or high-cost program support. Carriers that receive high-cost program support may use this support only for the “provision, maintenance, and upgrading of facilities and services for which the support is intended.” The high-cost program consists of five components, each with different eligibility criteria and different methods to determine the level of support. Four of the components provide support to carriers to offset the costs of the network, including local loops (primarily, the equipment that runs from the carrier’s facilities to the customer’s premises). The four components are high-cost loop, high-cost model, interstate access, and interstate common line. The fifth component, local switching support, provides support for very small carriers to offset the cost of their switching equipment. For incumbent carriers, eligibility for the components depends on the carrier’s size (as recognized by their classification as rural or nonrural) and the type of regulation the carrier is subject to—either rate-of-return or price-cap regulation. In 2007, USAC reported that there were 1,250 rural carriers subject to rate-of-return regulation, 105 rural carriers subject to price-cap regulation, 5 nonrural carriers subject to rate-of-return regulation, and 81 nonrural carriers subject to price-cap regulation. Based on the components for which they qualify, rural carriers receive support based on the costs they incurred, whereas based on the components for which they qualify, nonrural carriers receive part of their support based on projected costs using an FCC model. Table 3 summarizes each of the five high-cost program components, which carriers are eligible for each, the qualification criteria for each component, and the amount of support provided in 2007. For example, a rural carrier with less than 50,000 customers and subject to rate-of-return regulation could receive support through the high-cost loop, local switching, and interstate common line components. Unlike incumbents, competitors do not directly receive funds based on their costs or FCC’s model. Rather, once a competitor receives CETC status, it qualifies for the identical per-line level of support that the incumbent receives for the area it serves; this is known as the identical support rule. Since its inception in 1998, the high-cost program has increased nearly 153 percent, from $1.7 billion in 1998 to about $4.3 billion in 2007. This significant growth has raised concerns about the program’s long-term sustainability, efficiency, and effectiveness, as well as the adequacy of the oversight of carriers’ need for and use of support. Figure 1 illustrates the growth in the high-cost program, including both incumbents and competitors. Several factors have contributed to the growth in the high- cost program. In the early years of the program, support grew as FCC reduced access charges (a form of implicit support for carriers) to incumbents and offset those reductions with greater high-cost program support (a form of explicit subsidy). However, in recent years, the high- cost program has grown because of support provided to competitors, especially wireless companies. In response to concerns about the long-term sustainability of the high-cost program, FCC issued several Notices of Proposed Rulemaking (NPRM) in January 2008, seeking comment on proposals for comprehensive reform of the program. These NPRMs represent the culmination of efforts by FCC and the Joint Board to reform the program. FCC released an NPRM seeking comment on a Joint Board recommendation that the high-cost program be divided into three separate funds: broadband service, mobility (or wireless) service, and traditional provider of last resort service. FCC also released an NPRM seeking comment on changing the current funding mechanism for CETCs, namely eliminating the identical support rule and requiring CETCs to submit cost data. Finally, FCC released an NPRM that sought comment on implementing reverse auctions to determine the amount of high-cost program support to be given to an ETC; with reverse auctions, support generally would be determined by the lowest bid to serve the auctioned area. In this report, however, we will not assess or discuss the merits of the reform proposals; instead, we will review the high-cost program in its current state and discuss best practices that are critical for the future of the fund, regardless of which reform efforts are adopted, if any. In addition to these three proposals, on May 1, 2008, FCC released an order adopting an interim cap on high-cost program support for CETCs. FCC adopted the interim cap to stem the growth of the program while it considers these comprehensive reform proposals. Under this order, total annual support for CETCs will be capped at the level of support that they were eligible to receive in each state during March 2008. The high-cost program provides support to eligible carriers in all states, with higher levels of support going to more rural states. However, the high-cost program does not provide support consistently to carriers operating in similar locations, which can lead to different levels of telecommunications service across rural areas. In general, rural carriers receive more support than nonrural carriers. The high-cost program provides support for the provision of basic telephone service and, to a great extent, access to this service is available and widely subscribed to throughout much of the country. But the high-cost program also indirectly supports broadband service in some rural areas, particularly those areas served by rural carriers. Finally, the high-cost program supports competitive carriers, and support for these carriers has increased greatly in recent years. In 2007, carriers in all states received some form of high-cost program support, with higher levels of support going to more rural states. Generally, carriers operating in states with below-average population densities received more support than those in more densely populated states. For example, the five states in which carriers received the greatest amount of support in 2007 include Mississippi ($283 million), Texas ($246 million), Kansas ($222 million), Louisiana ($163 million), and Alaska ($161 million). While the average national population density is 190.1 people per square mile, these states have lower-than-average population densities, ranging from 1.2 people per square mile in Alaska to 98.4 people per square mile in Louisiana. Alternatively, the five states that receive the least support tend to have higher-than-average population densities, including Rhode Island ($31,000), Delaware ($245,000), Connecticut ($1.3 million), New Jersey ($1.7 million), and Massachusetts ($2.3 million); these states have population densities ranging from 436.9 people per square mile in Delaware to 1,176.2 people per square mile in New Jersey. Thus, at a broad, national level, high-cost program support flows to more rural states. However, the high-cost program does not provide support consistently to carriers operating in similar rural locations. To a large extent, this situation arises because of the program’s structure: the five different high- cost program components, each with different eligibility and methods to determine support. As mentioned earlier, rural carriers typically receive high-cost program support through components that base support on the carrier’s incurred costs. Thus, in the case of a rural carrier, the higher its actual costs, the more funding it receives. Because of this, the funding that a rural carrier receives depends on how much money it chooses to spend on its network. Additionally, the disparity between rural and nonrural carrier is even greater, as support to one carrier can be significantly more generous than support provided to another carrier for serving comparable areas. As mentioned earlier, nonrural carriers typically receive part of their high-cost program support (high-cost model) through a component that utilizes an FCC cost model; this model assumes the most efficient carrier providing service to existing customers. Since this model is not based on an individual carrier’s actual costs, investment in new network infrastructure will not lead to greater high-cost program support. Further, the threshold to receive support is greater for nonrural carriers; a rural carrier’s costs must exceed 115 percent of the national average whereas the statewide average cost must exceed approximately 131 percent of the national average for nonrural carriers. As such, nonrural carriers in 10 states currently are eligible for this funding, yet nonrural carriers in other states serve high-cost locations as well. Overall, rural carriers receive more funding than nonrural carriers and in 2007, rural carriers received $1.7 billion more in high-cost program support than nonrural carriers. In November 2007, the Joint Board recognized this situation itself, noting that “support for customers served by one kind of carrier can be significantly more generous than for comparably situated customers served by the other kind of carrier.” We found similar results in our site-visit states. In the 11 states we visited, 9 states had rural carriers receiving more funding than nonrural carriers. While rural carriers generally serve only rural areas, nonrural carriers also can serve large swaths of rural areas. In fact, carriers providing service in similar, even adjacent, areas can receive vastly different levels of high-cost program support. For example, as shown in figure 2, in Wisconsin, there are two nonrural carriers (areas in dark shading) that provide service to rural areas, yet these carriers do not qualify to receive the same types of support as rural carriers serving comparable adjacent areas. Similarly, in Oregon, 25 percent of the lines served by a large, national carrier are located in rural areas of the state; this carrier does not qualify to receive the same type of support for these lines that rural carriers in the same area do. The high-cost program directly and indirectly supports several types of service including (1) basic telephone service, (2) broadband service, and (3) wireless telephone service. Currently, the high-cost program provides support for the provision of basic telephone service. In the 1996 Act, the Congress stated as one of the principles underlying universal service that people in rural, insular, and high-cost areas should have access to telecommunications and information services that are reasonably comparable to those provided in urban areas and at comparable rates. However, the Congress did not define universal service or specify a list of services to be supported by the program. Instead, the 1996 Act recognized universal service as an evolving level of telecommunications services and directed FCC, after recommendations from the Joint Board, to establish a definition of the services to be supported by the program. In 1997, FCC adopted a set of communications services and “functionalities” for rural, insular, and high- cost areas that were to be supported by the high-cost program. To a great extent, access to basic telephone service is available and widely subscribed to throughout much of the country. One widely used measure of telephone subscribership is the penetration rate, which is based on survey data collected by the U.S. Census Bureau to estimate the percentage of U.S. households with telephone service. In 2007, the overall penetration rate in the United States was 95 percent, representing an increase of 0.9 percent since the inception of the high-cost program in 1998. While the penetration rate has increased marginally, there are several factors that could contribute to this result in addition to the high- cost program, including changes in income levels, greater diffusion of communications technology, or state-level programs. Appendix II shows penetration rates by state and changes in the percentage of households with telephone service from November 1983 through July 2007. Most of the rural carriers with whom we spoke agreed that support from the high-cost program has been an important source of their operating revenue. One recent study estimated that 30 percent of rural carriers’ annual operating revenues are derived from federal and state universal service programs, including the high-cost program. Our site visit interviews similarly suggest that rural carriers depend on high-cost program support to provide customers with access to affordable telephone rates. For example, one carrier with whom we spoke received nearly 80 percent of its annual operating revenues from the high-cost program. Moreover, many of the rural carriers we met with told us that they would be unable to provide the same range or quality of service to their customers without support from the high-cost program. Most of these carriers, who serve very remote and sparsely populated rural areas where it is very costly to provide telecommunications services, stated that without the support, they would likely need to increase the rates they charge their customers for basic services. Although there have been a number of proposals to revise the list of services supported by the high-cost program over the past decade, FCC has not taken action to change the original definition. To be eligible to receive high-cost program support, a carrier must offer each of the services and functionalities supported by the program. Additionally, carriers that receive high-cost program support may only use this support for the “provision, maintenance, and upgrading of facilities and services for which the support is intended.” While one of the universal service principles adopted in the 1996 Act is that all regions of the country should have access to advanced telecommunication and information services, the high-cost program does not explicitly support access to broadband services. While access to advanced services, such as broadband, is not included among the designated list of services supported by the high-cost program, the program has indirectly facilitated broadband deployment in many rural areas. In recent years, some carriers have been using high-cost program support to upgrade their telephone networks, including upgrading to fiber optic cable and extending it closer to their customers. Because of advances in telecommunications technology, these upgrades increase the capacity of the network, thereby facilitating the provision of advanced services, such as broadband. For example, many rural carriers with whom we spoke have or are replacing their copper wire with fiber optic cable. One carrier was in the early phases of a 7-year, $1.8 million expansion to install fiber-to-the-home for each customer in one of its exchanges that served about 700 lines. In addition to transitioning from copper to fiber, carriers are investing in modern switching equipment and remote terminals to improve the connection speeds available to their customers. For example, one carrier told us that it is currently installing more remote terminals to provide higher-speed broadband service, and that it currently has 96 remote terminals to serve customers spread out across a 1,300 square mile area. The availability of high-cost program support can, in part, determine whether deployment of broadband service is feasible in a rural area. In rural areas served by rural carriers, the high-cost program allows the carrier to recoup a large portion of the investment that facilitates broadband service since, as we mentioned earlier, these carriers receive high-cost program support based on their costs. Alternatively, in rural areas served by nonrural carriers, which generally do not receive as much funding as rural carriers and do not receive funding based on their costs, the network upgrades necessary for broadband service are less likely. As a result, the availability of broadband services to rural customers is largely determined by the type of carrier they are served by, and not where they are located. Rural carriers. Most rural carriers with whom we spoke had or were deploying advanced network features, such as fiber optic cable. For example, of the rural carriers we spoke with during our site visits, many stated they were able to provide broadband Internet service to 100 percent of their customers or service areas. In addition, FCC estimates that in 2007, 82 percent of households served by rural incumbent carriers had access to high-speed broadband connections. Nonrural carriers. Nonrural carriers with whom we spoke reported that they have broadband-enabled equipment in most or all facilities, but these carriers are generally unable to provide all rural customers with broadband service. Rather, only those customers residing relatively close to the carrier’s facility can receive broadband service. These carriers indicated that deploying broadband service to a wider service territory was not economical given the diffuse population in rural areas. Another impact of the high-cost program has been the increase in competitive carriers, especially wireless carriers, in rural areas. Beginning in 1997, FCC adopted a series of measures intended to encourage competition between carriers in rural areas to promote the principles of universal service. Among the actions taken by FCC was adopting the principle of “competitive neutrality” as part of the high-cost program. Under this principle, one carrier should not be favored over another carrier, and support should be available to any carrier that meets the requirements for operating as an ETC, regardless of the type of technology the carrier employs (such as wireline, wireless, or satellite). This principle was supported by granting high-cost program support to CETCs. While incumbents—both rural and nonrural—receive support based on their costs of providing service in an area or FCC’s cost model, CETCs receive support based on the number of lines they serve through a mechanism known as the identical support rule. Under this rule, CETCs in an area receive the same level of high-cost program support, on a per-line basis, as the incumbent carrier in that area. For example, if the incumbent carrier receives support that, based on the number of lines it serves, results in $20 of support per line, every competitor designated as an ETC in that area also will receive $20 in support for each line it serves in the same area regardless of its costs. ETC status is not required for a competitive carrier to operate in an area, but it is required if the carrier wants to receive high-cost program funding. As a result, the number of carriers seeking CETC status has increased dramatically, and the majority of newly designated carriers are wireless. Since 1998, the number of CETCs receiving support through the high-cost program has risen from a total of 2 carriers in 1998, to 362 competitive carriers in 2007. Of these 362 CETCs, 260 carriers—over 70 percent—are wireless carriers. Along with an increase in the number of carriers, the amount of funding provided to CETCs has increased over this time period, growing from $535,104 in 1999, with 100 percent going to wireless carriers, to $1.2 billion by 2007, with 98 percent of all CETC funding going to wireless carriers. A recent report by FCC estimated that at the end of 2006, wireless carriers had achieved an 80 percent penetration rate across the country, and according to the wireless carriers with whom we spoke, high-cost program support has allowed them to invest in improving and expanding their networks in rural areas where they would otherwise be unable to economically justify the investment. For example, one carrier told us that it can cost from $350,000 to $500,000 to install a cell tower in rugged or mountainous terrain, in addition to other installation expenses such as land rent and maintenance costs, but that in most cases, low population density in the area would not yield enough customers to recover the investment. Additionally, wireless companies and regulators with whom we spoke stated that the availability of wireless communication is a public safety concern; travelers along rural highways expect to be able to use cell phones in the event of an emergency. However, wireless carriers often lack the economic incentive to install cell phone towers in rural areas where they are unlikely to recover the installation and maintenance costs, but high-cost program support allows them to make these investments. In the 1996 Act, the Congress established the principles underlying universal service, which provide a clear purpose for the high-cost program. However, since 1998, FCC has distributed over $30 billion in high-cost funding without developing specific performance goals for the program. Additionally, FCC has not developed outcome-based performance measures for the program. While FCC has begun preliminary efforts to address these shortcomings, its efforts do not align with practices GAO and OMB have identified as useful in developing successful performance goals and measures. In the absence of program goals and data pertaining to the program’s performance, the Congress and FCC may be limited in their ability to make informed decisions about the future of the program. In the 1996 Act, the Congress clearly established the principles underlying universal service. In particular, the Congress said that “quality services should be available at just, reasonable, and affordable rates.” Additionally, the Congress said that consumers in all regions of the country, including “those in rural, insular, and high-cost areas” should have access to telecommunications and information services that are “reasonably comparable to those services provided in urban areas and that are available at rates that are reasonably comparable to rates charged for similar services in urban areas.” These guiding principles provide a clear purpose for the high-cost program. However, 12 years after the passage of the 1996 Act and after distributing over $30 billion in high-cost program support, FCC has yet to develop specific performance goals and measures for the program. We were unable to identify any performance goals or measures for the high-cost program. In its 2005 program assessment of the high-cost program, OMB also concluded that the program did not have performance goals or measures. OMB reported that the program neither measures the impact of funds on telephone subscribership in rural areas or other potential measures of program success, nor bases funding decisions on measurable benefits. OMB also reported that the high-cost program does not have specific, long-term performance measures that focus on outcomes and meaningfully reflect the purpose of the program. Additionally, in February 2005, we reported that FCC had not established performance goals and measures for the E-Rate program, the second-largest universal service program. At that time, we observed that under the Government Performance and Results Act, FCC was responsible for establishing goals for the universal service programs, despite the fact that the 1996 Act did not specifically require them. Further, FCC has not adequately defined the key terms of the high-cost program’s purpose. For example, the Congress directed FCC to ensure consumers in rural areas received access to “reasonably comparable” services at “reasonably comparable” rates to those in urban America. To address this, in a report and order issued in 1999, FCC defined “reasonably comparable” as “a fair range of urban/rural rates both within a state’s borders, and among states nationwide.” This definition only focused on rates and did not address what FCC considered “reasonably comparable” services; 2 years after FCC issued this definition, its adequacy was challenged in federal court. In July 2001, the Tenth Circuit Court rejected FCC’s use of this definition, and required that FCC more precisely define “reasonably comparable” in reference to rates charged in rural and urban areas.” Subsequently, in October 2003, FCC attempted to again define “reasonably comparable,” this time stating that rates are considered reasonably comparable if they fall within two standard deviations of the national urban average. Again, this definition did not address what services should be supported by the high-cost program, and again in February 2005, the Tenth Circuit Court rejected the adequacy of this definition, stating that it was not clear how this new definition preserved and advanced universal service. To date, FCC has not adopted any other definitions for “reasonably comparable” rates or services. In June 2005, FCC issued a Notice of Proposed Rulemaking, in which it sought comment on establishing useful outcome, output, and efficiency measures for each of the universal service programs, including the high- cost program. In this notice, FCC recognized that clearly articulated goals and reliable performance data would allow for assessment of the effectiveness of the high-cost program and would allow FCC to determine whether changes to the program are needed. As of August 2007, FCC had not established performance goals and measures for the high-cost program, and FCC stated it did not have sufficient data available to establish high-cost program performance goals. To begin addressing this shortcoming, FCC started collecting performance data from USAC on a quarterly basis, including: number of program beneficiaries (i.e. ETCs) per study area and per wire number of lines, per study area and per wire center, for each ETC; number of requests for support payments; average (mean) dollar amount of support and median dollar amount of support for each line for high-cost ETCs; total amount disbursed—aggregate and for each ETC; time to process 50 percent, 75 percent, and 100 percent of the high-cost support requests and authorize disbursements; and rate of telephone subscribership in urban vs. rural areas. However, these efforts generally do not align with known practices for developing performance goals. We have reported that in developing performance goals, an agency’s efforts should focus on the results it expects its programs to achieve, that is, the differences the program will make in people’s lives. In doing this, an agency’s efforts should work to strike difficult balances among program priorities that reflect competing demands and provide congressional and other decision makers with an indication of the incremental progress the agency expects to make in achieving results. Additionally, we have identified many useful practices for developing program goals and measures; these practices include developing goals and measures that address important dimensions of program performance, developing intermediate goals and measures, and developing goals to address mission-critical management problems. As seen in table 4, we found that FCC’s efforts do not align with useful practices we have identified for developing successful goals. Additionally, FCC’s efforts do not align with guidance set forth by OMB. According to OMB, output measures describe the level of a program’s activity, whereas outcome measures describe the intended result from carrying out a program or activity and efficiency measures capture a program’s ability to perform its function and achieve its intended results. In its Program Assessment Rating Tool Guidance, OMB noted that measures should reflect desired outcomes. Yet, FCC’s data collection efforts focus on program outputs, and not program outcome or efficiency. Therefore, FCC’s efforts will be of limited use in illustrating the impacts of the high-cost program or how efficiently the program is operating. Clearly articulated performance goals and measures are important to help ensure the high-cost program meets the guiding principles set forth by the Congress. These guiding principles include comparable rates and services for consumers in all regions of the country. Yet, as mentioned earlier, the program’s structure has contributed to inconsistent distribution of support and availability of telecommunications services across rural America, which is not consistent with these guiding principles. Outcome-based performance goals and measures will help illustrate to what extent, if any, the program’s structure is fulfilling the guiding principles set forth by the Congress. Finally, FCC is reviewing several recommendations and proposals to restructure the high-cost program. Yet, because there is limited information available on what the program in its current form is intended to accomplish, what it is accomplishing, and how well it is doing so, it remains unclear how FCC will be able to make informed decisions about which option is best for the future. Internal controls mechanisms for the high-cost program focus on three areas. Yet, each area has weaknesses. The carrier certification process exhibits inconsistency across states and carriers, the carrier audits have been limited in number and types of reported findings, and carrier data validation focuses primarily on completeness and not accuracy. Collectively, these weaknesses hinder FCC’s ability to understand the risks associated with noncompliance with program rules. Further, these weaknesses could contribute to excessive program expenditures. In particular, the high-cost program could incur excessive expenditures because of carrier inefficiencies, excessive payments to carriers, and provision of funding for nonsupported services. Internal control mechanisms for the high-cost program focus on three areas: (1) carrier certification, (2) carrier audits, and (3) carrier data validation processes. In each of these three areas, we found weaknesses in the internal control mechanisms. Annual certification is the primary tool used to enforce carrier accountability for use of high-cost program support, yet the certification process does not have standardized requirements. FCC requires that all states annually certify that all federal high-cost program support provided to eligible carriers in their state will be used only for the provision, maintenance, and upgrading of facilities and services for which the support is intended. It is up to the states to determine if carriers are operating in accordance with these guidelines. Generally, states do so by collecting information from carriers regarding their use of high-cost program funds. However, states have different requirements for what information carriers must submit. Additionally, if a state does not have jurisdiction over a carrier, then the carrier provides annual certification data directly to FCC. As a result, carriers are subject to different levels of oversight and documentation requirements to demonstrate that high-cost program support was used appropriately. FCC established requirements for information that must be submitted by the carriers it designates as ETCs. Incumbent carriers designated as ETCs by FCC must provide a sworn affidavit stating they are using high-cost program funding only for the provision, maintenance, and upgrading of facilities and services for which the support is intended. Additionally, all carriers—incumbent and competitive—designated as ETCs by FCC must provide: progress reports on the ETC’s 5-year service quality improvement plan; the number of unfulfilled service requests from potential customers; the number of complaints per 1,000 handsets or lines; certification that the ETC is complying with applicable service quality standards and consumer protection rules; certification that the ETC is able to function in emergency situations; certification that the ETC is offering a local usage plan comparable to that offered by the incumbent in the relevant service areas; and certification that the carrier acknowledges that FCC may require it to provide equal access to long-distance carriers in the event that no other eligible telecommunications carrier is providing equal access within the service area. While FCC encourages state regulatory commissions to adopt these requirements, it is not mandatory. Nevertheless, in our survey of state regulatory commissions, we found that many states require carriers to provide information similar to some of the information collected by FCC, particularly with respect to quality-of-service data. For example, FCC requires carriers to submit annual information on the number of unfulfilled service requests from potential customers, the number of complaints per 1,000 handsets or lines, as well as detailed information on outages the carrier experienced. According to our survey, we found that many states require similar information from carriers. Additionally, in our survey, we asked the state regulatory commissions to specify the types of quality-of-service measures they require for incumbent, competitive wireline, and wireless carriers. We found that state requirements are somewhat varied across the three different types of carriers. For example, of the 45 states that indicated they measure consumer complaints, 22 states indicated they require this information for at least one type of carrier but not all types of carriers. (See table 5.) In addition to the quality-of-service information, we found that state regulatory commissions collect a variety of information pertaining directly to the annual certification process. States most frequently require carriers to submit affidavits that future support will be used for its intended purpose; plans for quality, coverage, or capacity improvements; and evidence that past support was used for its intended purposes. However, according to our survey, 10 state regulatory commissions require incumbent carriers to submit only an affidavit, with no additional information. Additionally, in some instances, these requirements vary based on the type of carrier. (See table 6.) Carrier audits are the primary tool used in monitoring and overseeing carrier activities, but these audits have been limited in number and types of reported findings. While the 1996 Act does not require audits, FCC has authorized USAC to conduct audits. FCC, USAC, and some state regulatory commissions conduct carrier audits for the high-cost program. USAC audits. USAC operates an audit program to determine if carriers are complying with the program’s rules. This audit program has been limited; according to USAC officials, since 2002, USAC has conducted about 17 audits, from more than 1,400 carriers participating in the high-cost program (approximately 1.2 percent coverage). USAC officials told us these audits are time-consuming, and have yielded limited findings because participants did not maintain adequate documentation to validate their information. This occurred for two reasons: (1) the high-cost program had no requirement that carriers retain documents and (2) rural carriers receive funding as a reimbursement for costs incurred 2 years prior to the receipt of support and therefore carriers did not keep records going back a sufficient period of time for the audit. To address these problems, in August 2007, FCC imposed and USAC implemented document retention rules for high-cost program participants; participants are now required to maintain records that can be used to demonstrate to auditors that support received was used consistent with the 1996 Act and FCC’s rules for 5 years. FCC audits. In 2006 and 2007, FCC’s Office of Inspector General (OIG) instructed USAC to begin conducting audits and assessments to determine the extent to which high-cost program beneficiaries were in compliance with program rules. These audits and assessments have two objectives: (1) validate the accuracy of carrier self-certifications—audits—and (2) provide a basis for identifying and estimating improper payments under the Improper Payments and Information Act of 2002 (IPIA)— assessments. To conduct these audits and assessments, a random sample of 65 out of about 1,400 carriers was selected by OIG. In meeting its first objective, findings were similar to USAC’s audit findings, in that it could not be determined if the information that carriers attested to in their annual certifications was accurate because carriers did not have proper documentation to validate their information. For the second objective, OIG reported that the high-cost program had an estimated 16.6 percent rate of improper payments. In response to these findings, USAC maintained that this error rate was primarily indicative of carrier noncompliance with program rules, and not a result of payments made to carriers for inaccurate amounts. For example, USAC stated that these payments were categorized as erroneous because the carrier failed to comply with high-cost program rules such as meeting filing deadlines or completing required documentation. In November 2007, a second round of beneficiary audits and assessments was begun to further review program compliance and should be completed by the end of calendar year 2008. State audits. In addition to the USAC and FCC OIG audits, 7 of the 50 state regulatory commissions that responded to our survey reported that they audit incumbent carriers. These audits focus on the appropriate use of high-cost program funding, the accuracy of carrier-reported costs, and the compliance with quality-of-service standards. Two of the 7 states reported that they audit all incumbent carriers, while the remaining 5 states reported that audits are based on a risk assessment of the carrier, or triggered by unusual behavior on the part of the carrier. While these 7 states conduct audits, states generally do not revoke carrier’s ETC status. According to our survey, since 2002, one state reported it had revoked a carrier’s ETC status (for a competitive carrier). Additionally, during our site visits, several state officials told us they did not conduct audits because they did not feel it was the state’s jurisdiction or they lack the resources to perform in-depth reviews of carriers’ use of high-cost program funds. Data validation processes to ensure the reliability of financial data primarily focus on the completeness of the data provided by carriers, but not the accuracy of the data. Incumbents submit cost and line count data directly to NECA and USAC; these cost and line count data are used to qualify carriers for and to calculate the amount of carriers’ high-cost program support. NECA is responsible only for collecting carrier cost and line count data for the high-cost loop support component of the high-cost program. All cost data NECA collects for this component are subject to several electronic validations which primarily focus on ensuring that all required data are reported and that the data ranges are consistent with information reported in previous years. In addition, NECA compares reported cost data with information provided in carriers’ audited financial statements to identify any discrepancies. According to NECA officials, these statements are available for about 90 percent of its member carriers. If inaccuracies are found, member carriers are required to provide NECA with an explanation to resolve the situation, but no action is taken against the carrier. NECA officials do not conduct any additional oversight of the line count data they receive. USAC collects cost and line count data for the remaining components of the high-cost program, and similarly to NECA, these data are subject to several electronic data validations for completeness. While these validations and reviews provide NECA and USAC with opportunities to identify input errors, they do not addresses whether or not the data provided by participants are accurate or if the money spent addresses the intended purposes of the high-cost program. While some internal control mechanisms are in place, the weaknesses we identified hinder FCC’s ability to assess the risk of noncompliance with program rules. In particular, the internal control mechanisms may not fully address the following concerns, which could contribute to excessive program expenditures. Cost-effectiveness. In some instances, carriers receive high-cost program support based on their costs. Historically, carriers often were subject to rate-of-return regulation, wherein a state regulatory commission would assess the carrier’s costs and investments to ensure these were appropriate and necessary. Of the 50 respondents to our survey of state regulatory commissions, 33 apply rate-of-return regulation to rural incumbent carriers, 13 apply it to nonrural incumbent carriers, and 4 apply it to competitive wireline carriers. Further, during our site visits, several state commissions told us that rate cases in which a state regulatory commission evaluates a carrier’s costs and investments are very infrequent, if they take place at all. As such, there is limited assessment of the cost-effectiveness of carriers and their investments. Further, as OMB noted, there is no evidence that the program explicitly encourages carriers to achieve efficient and cost-effective delivery of service; rather, the program simply makes rural incumbent carriers whole, regardless of their investment decisions or business model, or the presence of competition in the market by guaranteeing “reasonable” rates of return. The combination of a funding mechanism that does not encourage cost- effectiveness, combined with a lack of detailed oversight, may not yield the most cost-effective program expenditures. Accuracy of cost and line count data. ETCs and CETCs receive high-cost program support based on their costs and line counts. However, as mentioned above, FCC, USAC, and NECA data collection efforts generally focus on completeness and consistency of carriers’ data submissions, but not the accuracy of the data. Further, USAC, FCC, and state regulatory commissions audit a small fraction of program participants, and in the case of FCC’s IPIA audits, these audits do not assess the accuracy of cost and line count data which are used to form the basis for carrier support. Inaccuracies in cost and line count data, which are not uncovered through review, could facilitate excessive program expenditures. Appropriate use of high-cost program support. The high-cost program rules delineate the appropriate uses of the program’s support. As we discussed, carriers must annually certify that their use of high-cost program support complies with the program rules. However, the self- certification process varies based on who oversees the carrier; further, there is little follow-up to assess whether carriers’ actions are consistent with the certifications. As such, program administrators cannot fully assess whether carriers are appropriately using high-cost program support. Thus, program expenditures could prove excessive if high-cost program funding is used to support services not covered by the program (such as broadband). In the 1996 Act, the Congress said that consumers in “rural, insular, and high-cost areas” should have access to services and rates that are “reasonably comparable” to consumers in urban areas. To respond to this task, FCC modified and expanded the high-cost program. In the intervening 10 years, FCC has distributed over $30 billion to carriers, with much of this support coming from fees charged to consumers. Yet, FCC has not established performance goals or measures for the program. Thus, it is neither clear what outcomes the program is intended to produce nor what outcomes the program has achieved. What we and the Joint Board found were differences in telecommunications services in rural areas across the country. For example, in some rural areas, carriers receive generous support and provide advanced services, such as fiber-to-the- home, while in other rural areas, carriers receive little or no support and provide basic services. In addition to the lack of performance goals and measures, the internal control mechanisms in place have weaknesses, which hinder FCC’s ability to assess the risk of noncompliance with program rules and ensure cost-effective use of program funds. The internal control mechanisms are inconsistent, limited in number, and appear more concerned with data completeness than accuracy. Thus, for example, it is not clear that the program ensures the most cost-effective delivery of services to rural areas. Therefore, program expenditures may be higher than necessary. These problems raise concerns about past and current program expenditures. But, they also raise concerns about the future of the program. In January 2008, FCC issued several notices proposing fundamental, policy-oriented reform of the program. For example, FCC proposed reverse auctions for the program, but it is not clear how FCC can assess this proposal when it does not know what goals the program should achieve or how it will measure program outcomes. Additionally, the Joint Board proposed separate funds for broadband, mobility, and provider-of-last resort services, with a $4 billion funding level that was based on the current level of program expenditures. But, it is not clear that the $4 billion is the correct funding level. Without performance goals, measures, and adequate internal controls, it will be difficult for FCC to assess these proposals. Finally, failure to address these problems may undermine support for the program over time, as program expenditures continue to increase. To strengthen management and oversight of the high-cost program, we recommend that the Chairman, FCC take the following two actions: 1. To better ensure that the high-cost program supports the purpose it is intended to fill, FCC should first clearly define the specific long-term and short-term goals of the high-cost program and subsequently develop quantifiable measures that can be used by the Congress and FCC in determining the program’s success in meeting its goals. 2. To ensure a robust internal control environment that supports performance-based management, FCC should identify areas of risk in its internal control environment and implement mechanisms that will help ensure compliance with program rules and produce cost-effective use of program funds. We provided a draft of this report to FCC and USAC for their review and comment. FCC noted that it was aware of, and had addressed or planned to address, the shortcomings we identified in the report. However, FCC noted that it would issue a Notice of Inquiry to seek information on ways to further strengthen its management and oversight of the high-cost program. FCC and USAC both provided information to further clarify the actions that are currently underway and provided technical comments that we incorporated where appropriate. The written comments of FCC and USAC appear in appendices III and IV, respectively. In its comments, FCC reiterated the status of its existing efforts to strengthen the management and oversight of the high-cost program, as well as to restrain the growth in program expenditures. In particular, FCC cited the OIG audits, the new document retention requirements, and the Memorandum of Understanding (MOU) between FCC and USAC. We agree that these are important efforts, but they do not resolve the shortcomings we identified in the report. FCC also noted that we did not mention the MOU in the report; while we did not cite the MOU, we did incorporate elements of the MOU in the report, including, for example, the requirement that USAC collect and report performance data on a quarterly basis. In addition, FCC noted that it issued several NPRMs seeking comments on proposals to restrain the growth in program expenditures, including removal of the identical support rule and adoption of reverse auctions, and noted that we did not consider these reform proposals in our report. We did provide background information on these proposals; however, we did not provide an assessment of these proposals since FCC was actively seeking comments on the proposals and the outcome of the proposals was speculative; further, our findings and recommendations regarding management and oversight are applicable to the program in general, regardless of the specific reform proposal adopted. As agreed with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the date of this letter. At that time, we will send copies of this report to the appropriate congressional committees, the Chairman of the Federal Communications Commission, and the Chairman of the Universal Service Administrative Company. We will also make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you have any questions about this report, please contact me at (202) 512- 2834 or goldsteinm@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Contact information and major contributors to this report are listed in appendix V. This report examines the operation of the high-cost program of the Universal Service Fund. In particular, the report provides information on (1) the effect that the structure of the program has on the levels of support and types of services available in high-cost areas; (2) the extent that the program has performance goals and measures; and (3) the extent that the program has mechanisms in place to prevent and detect fraud, waste, and abuse. To respond to the overall objectives of this report, we interviewed officials from the Federal Communications Commission (FCC) and the Universal Service Administrative Company (USAC). In addition, we reviewed FCC and USAC documents, as well as relevant legislation and federal regulations. We also interviewed industry associations, national wireline and wireless companies, the National Exchange Carrier Association (NECA), and other individuals with knowledge of the high-cost program. We reviewed USAC data on the distribution of high-cost funds across states and companies. Finally, we compared FCC, USAC, and state policies to GAO and Office of Management and Budget (OMB) guidance. Table 7 lists the individuals and organizations with whom we spoke. For the first and third objectives, we conducted site visits in six states: Alabama, Iowa, Montana, Oklahoma, Oregon, and Wisconsin. We used a multistep process to select these six states. First, we divided states into Census Bureau regions, excluding states where (1) no competitive eligible telecommunications carriers (CETC) received support in 2006 and (2) the urban population was equal to or above average, since the high-cost program provides support for rural areas. Second, we selected states within each region based on the number of eligible telecommunications carriers (ETC) and CETCs present in the state. Within each state, we interviewed the state regulatory commission (that is, the state agency responsible for regulating telephone service within the state), “rural” and “nonrural” ETCs, and CETCs. In some states, we also interviewed cost consultants, state industry associations, and wireless carriers. To test our structured interview and site selection methodology, we also conducted site visits in the following states: Arizona, Maine, Massachusetts, New Hampshire, and New Mexico. We interviewed similar state and industry officials in these five states. For the third objective, we conducted a survey of state regulatory commissions. The survey field period was from December 12, 2007, to February 8, 2008, and sought information pertaining to the state’s regulation of telephone service; the state’s internal control procedures for incumbent, competitive wireline, and competitive wireless carriers receiving high-cost support in the state; and the state’s high-cost program, if any. To help ensure that the survey questions were clear and understandable to respondents, and that we gathered the information we desired, we conducted pretests with relevant officials in Mississippi, North Carolina, Pennsylvania, Virginia, and Washington. The survey was available online to officials in the 50 states and the District of Columbia on a secure Web site. We received complete responses from 50 of the 51 commissions we surveyed, for an overall response rate of 98 percent. This report does not contain all the results from the survey. The survey and a more complete tabulation of the results can be viewed at GAO-08-662SP. We conducted this performance audit from July 2007 through June 2008 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix II: Telephone Penetration Rate by State (Percentage of Households with Telephone Service) November 1983 (%) July 2007 (%) November 1983 (%) July 2007 (%) The following are GAO’s comments on the Federal Communications Commission’s letter dated May 16, 2008. 1. While we did not specifically cite the Memorandum of Understanding (MOU), we did discuss elements of this document. With respect to internal controls, the MOU states that USAC “shall implement a comprehensive audit program to ensure that USF monies are used for their intended purpose, to verify that all USF contributors make the appropriate contributions in accordance with the rules, and to detect and deter potential waste, fraud, and abuse. shall work under the oversight of the OIG in hiring contractors and auditing contractors . . .” While we acknowledge these recent efforts to conduct audits of USF (Universal Service Fund) program contributors and beneficiaries, as discussed in this report, we found that with respect to the high-cost program, these efforts have been limited and yielded limited results. For example, USAC has conducted about 17 audits, from more than 1,400 participating carriers, and participants did not maintain adequate information for the auditors to validate their information. The MOU also states that USAC “shall implement effective internal control over its operations, including the administration of the USF and compliance with applicable laws and regulations. will implement an internal control structure consistent with the standards and guidance contained in OMB Circular A-123, including the methodology for assessing, documenting, and reporting on internal controls. . .” During our review, USAC officials made us aware of the actions they are taking to develop a comprehensive, internal control framework for USAC’s internal operations, such as procedures to ensure that cash disbursements are consistent with funds due to participating carriers. While we encourage these efforts, USAC’s internal operations were not in the scope of our objectives, and these efforts do not address the issues we raised in the report—weak and limited internal control mechanisms specifically aimed at the high-cost program beneficiaries. 2. We are aware that efforts to promote universal service in rural areas pre-date the 1996 Act, and include background information on these efforts on pages 7-8 of the report. However, to avoid any confusion, we modified the report text to note that FCC modified and expanded the high-cost program after the Telecommunications Act of 1996. 3. Again, while we did not specifically cite the MOU, on page 28 of the report, we did discuss the performance data that FCC requires USAC to collect and report on a quarterly basis. Interestingly, in a previous meeting with USAC and in USAC’s written comments, USAC noted that it is not authorized to collect all the performance data required by FCC. In particular, of the seven categories of performance data, USAC said it was not authorized to collect some portions of three categories, including the number of program beneficiaries per wire center, the number of lines per wire center (except for the high-cost model component), and the rate of telephone subscribership in urban vs. rural areas. Thus, it is unclear how effective this data collection effort will be in developing performance goals and measures. 4. We changed the text to be consistent with the 1996 Act. 5. We did not assert that FCC had the authority to impose mandatory standards on state regulatory commissions, although, since the issue has not been adjudicated, it is unclear whether the statute prohibits FCC from imposing mandatory standards. Irrespective of FCC’s authority to impose mandatory standards, the inconsistent requirements imposed by the states represent a weakness in the high- cost program’s internal controls. As USAC noted in its written comments, “if states adopted similar requirements there would be more standardized requirements across all ETCs thereby enabling USAC to conduct more comprehensive audits to ensure ETCs are using High Cost funds for the purposes intended.” 6. We changed the text to be consistent with the 1996 Act. 7. On page 37 of this report, we discuss the steps NECA takes to verify the accuracy of the data that carriers submit, including analyzing trends and comparing cost data with information in carriers’ audited financial statements. Although, as we also discuss, NECA is responsible only for collecting carrier cost and line count data for the high-cost loop support component, representing only one of the five high-cost program components. Further, trend analysis does not necessarily ensure the accuracy of the underlying data. In its comments on this report, USAC, which also performs extensive trending validations, noted that “absent a full-scale audit, it is difficult to determine the level of accuracy of the information provided by the carriers.” 8. We acknowledge that FCC’s Office of Inspector General (OIG) Improper Payments and Information Act of 2002 (IPIA) audits included a component to determine carrier compliance with high-cost program rules. While FCC’s comments state these audits were designed to render an auditor’s opinion on the accuracy of carrier data, it was unclear to us that these audits specifically addressed accuracy of carrier cost and line counts. In the OIG’s Initial Statistical Analysis of Data from the 2006/2007 Compliance Audits, the reasons for carrier noncompliance focused on procedural noncompliance. These reports attributed inadequate document retention; inadequate auditee processes or policies and procedures; inadequate systems for collecting, reporting, or monitoring data; auditee weak internal controls; and auditee data entry error. These reports do not discuss the accuracy of carrier’s cost or line-count data. 9. We acknowledged the Notice of Proposed Rulemakings that FCC issued to address the growth in the high-cost program’s expenditures and provided background information on these proposals. However, we did not provide an assessment of these proposals since FCC was actively seeking comments on the proposals, and the outcome of the proposals was speculative. Further, our findings and recommendations regarding management and oversight of the high-cost program are applicable to the program in general, regardless of the specific reform proposal adopted. In making our recommendations, we are not implying that FCC should discontinue policy-oriented reform of the high-cost program; rather, these efforts are complementary. 10. On page 14 of the report, we provide a discussion of the factors contributing to the growth of high-cost program expenditures, and figure 1 provides a visual illustration of the growth in both incumbent and competitive support. Further, on page 24, we provide detailed information on the growth in the number of CETCs and the overall financial support provided to CETCs. In addition to the individual named above, Michael Clements, Assistant Director; Tida Barakat; Brandon Haller; Amanda Krause; Carla Lewis; Michael Meleady; Joshua Ormond; Donell Ries; Stan Stenerson; Mindi Weisenbloom; Crystal Wesco; and Elizabeth Wood made key contributions to this report.

Summary: In the Telecommunications Act of 1996 (1996 Act), the Congress said that consumers in "rural, insular, and high-cost areas" should have access to services and rates that are "reasonably comparable" to those in urban areas. To implement the 1996 Act, the Federal Communications Commission (FCC) modified and expanded the high-cost program. The program provides funding to some telecommunications carriers, facilitating lower telephone rates in rural areas. GAO was asked to review (1) the effect that the program structure has on the level of support and types of services in rural areas, (2) the extent to which FCC has developed performance goals and measures for the program, and (3) the extent to which FCC has implemented internal control mechanisms. GAO reviewed relevant documents; interviewed federal and state officials, industry participants, and experts; conducted 11 state site visits; and conducted a survey of state regulators, available online at GAO-08-662SP . The high-cost program's structure has resulted in the inconsistent distribution of support and availability of services across rural America. The program provides support to carriers in all states. However, small carriers receive more support than large carriers. As a result, carriers serving similar rural areas can receive different levels of support. Currently, the high-cost program provides support for the provision of basic telephone service, which is widely available and subscribed to in the nation. But, the program also indirectly supports broadband service, including high-speed Internet, in some rural areas, particularly those areas served by small carriers. The program provides support to both incumbents and competitors; as a result, it creates an incentive for competition to exist where it might not otherwise occur. There is a clearly established purpose for the high-cost program, but FCC has not established performance goals or measures. GAO was unable to identify performance goals or measures for the program. While FCC has begun preliminary efforts to address these shortcomings, the efforts do not align with practices that GAO has identified as useful for developing successful performance goals and measures. For example, FCC has not created performance goals and measures for intermediate and multiyear periods. In the absence of performance goals and measures, the Congress and FCC are limited in their ability to make informed decisions about the future of the high-cost program. While some internal control mechanisms exist for the high-cost program, these mechanisms are limited and exhibit weaknesses that hinder FCC's ability to assess the risk of noncompliance with program rules and ensure cost-effective use of program funds. Internal control mechanisms for the program consist of (1) carrier certification that funds will be used consistent with program rules, (2) carrier audits, and (3) carrier data validation. Yet, each mechanism has weaknesses. The carrier certification process exhibits inconsistency across the states that certify carriers, carrier audits have been limited in number and reported findings, and carrier data validation focuses primarily on completeness and not accuracy. These weaknesses could contribute to excessive program expenditures.