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State Universal Service Funds:
Evolution to Broadband?

Pamela Sherwood
MARC June 15, 2009
Speaking on Behalf of
• tw telecom
    • tw telecom inc.(NASDAQ: TWTC), headquartered in Littleton,
      Colorado, is a leading provider of managed voice and data networking
      solutions to a wide array of businesses and organizations. One of the
      country‘s premier competitive telecom carriers, tw telecom integrates
      data, dedicated Internet access, and local and long distance voice
      services for long distance carriers, wireless communications companies,
      incumbent local exchange carriers, and enterprises doing business in
      healthcare, finance, higher education, manufacturing, and hospitality
      industries; as well as to state and local government and military
      organizations. tw telecom currently delivers service in 30 states and 75
      U.S. metropolitan areas.




2
Speaking on Behalf of
• MACC
    • the Midwest Association for Competitive Communications
      (MACC)—a coalition of telecommunications companies
      and interested businesses. MACC is dedicated to
      supporting a regulatory environment that fosters
      competition in the communications marketplace.
    • Carrier members of the coalition include:
             Access Point, Inc.              Level 3 Communications, Inc.
             Birch Communications            Nuvox
             Cavalier Telephone              One Communications
             CBeyond                         PaeTec, Inc./McLeodUSA, Inc.
             Communications, LLC             Socket Telecom, LLC
             CIMCO Communications            tw telecom inc.
             Covad Communications            TDS Metrocom LLC*
             Company                         XO Communications, Inc.
             Data Net Systems, LLC           360networks (USA) Inc
             Globalcom, Inc. / First
             Communications, Inc.      Not all MACC members agree with the
                                       positions presented here



3
Overview
•       Broadband ―Hot Topic‖: Lots of Questions – Not Many Answers
•       Federal USF Debate for Broadband Inclusion
          • Segregated Mechanism
          • Infrastructure program
          • Mandate as condition for receipt of USF funding
•       Goals of State USF Programs – Can/Should they evolve to include
        broadband?
•       Principles and Lessons Learned
          • Oversight and Accountability - Texas Example
          • Assessment of Effectiveness of programs – Wisconsin Example
          • Competitive neutrality – assessments and distributions
          • Need-based expansion consistent with the goals
               • Wisconsin diversion of $12.6M of USF funds
               • Indiana RLEC attempt to recover competitive losses
               • A form of taxation




    4
Broadband is the “Hot Topic” Du Jour
•       American Recovery and Reinvestment Act of 2009 Provides $7.2 Billion for
        Broadband Deployment
         • FCC Issued a Notice of Inquiry (GN Docket No. 09-51)
               • Comments Due June 8, Replies Due July 7. Key USF-Broadband
                   Questions at Paragraphs 39-41
               •   How should we determine the effectiveness and efficiency of existing USF
                   programs as it relates to achieving our national broadband goals?
               •   Are there opportunities to leverage the stimulus program funds and
                   universal service funds to maximize broadband deployment, and at the
                   same time prevent ―double dipping‖?
               •   Should we modify the existing USF programs? Should we make
                   broadband a supported service? Should we create new programs? Should
                   such programs be designed around the delivery of broadband?
               •   Should we require contributions to USF from broadband providers? What
                   effect would that have on the economics of broadband deployment?
               •   What effect would inclusion of broadband as a supported service have on
                   the size of the USF and on contribution requirements?




    5
                 Expansion of USF to Broadband Raises
                           Other Hot Issues
•       Representative Cliff Stearns (R-FL) at the March 12, 2009 House Communications,
        Technology & Internet Subcommittee hearing advocated:
         • Wait and see what happens in the next 2 years to assess the degree to which the
           $7.2B in Stimulus Funding facilitates broadband for un-served areas.
         • ―Let‘s take that two years and examine the effectiveness of that program‖ instead of
           adding the broadband build-out requirements to USF.
•       Don‘t throw additional money into the broken USF mechanism
         •   USF is one leg of a three-legged stool – other legs are access charges and local
             competition
                 •   Intercarrier Compensation Reform
                 •   Contribution Assessment Methodologies
         •   Federal USF surcharge is now at 11.3%
•       Expansion would increase USF ‗tax‘ burden paid by providers and their end users.
•       Is there a ―need‖?
         • Will Broadband Stimulus funding meet the broadband deployment goals?
         • Broadband availability is increasing in response to conventional market incentives and
           advances in technology
         • Fixed wireless technologies continue to improve




    6
Inclusion of Broadband – The Federal Debate
    • Segregated Mechanism: Joint Board Recommendation
         • Joint Board Recommendation: WC Docket No. 05-337, CC Docket No. 96-
           45 (2007)
               – Broadband Fund – tasked with
                   » disseminating broadband internet services to unserved areas with grants for construction.
                   » Grants for new construction to enhance broadband in underserved areas
                   » Providing operating subsidies to broadband internet providers where low customer density
               – Estimated initial funding needed of $300 million a year
    • Infrastructure program
           • AT&T – Proposes that high cost fund be transitioned to 2 separate funds:
             Broadband Incentive Fund (fixed networks) and Advanced Mobility Fund
             (mobile wireless networks)
           • one time funding to construct and identify support necessary to deploy and
             maintain the infrastructure for designated area for the term - 7 years
    • Could be limited to one provider in each area
    • Have to demonstrate up-front costs – proof of construction program
    • Amount of funds available would be determined before
    • Would solve the problem of on-going support when no longer needed
    • Require a commitment to allowing access.




7
Inclusion of Broadband – The Federal Debate

    • Inclusion as a Supported Service:
         • Joint Board Recommendation proposes Broadband be a
           supported service.
         • NARUC Resolution advocates creation of a 3 year trial that
           includes broadband internet access as an eligible service
           for Life-Line and Link-Up – open to all providers.
         • Contributors include wireline, wireless, paging service,
           interconnected VOIP providers.

    • Issue: under existing 254(c)(1) definition, can it be a
     supported ―telecommunications service‖ when FCC has
     ruled that is an ―information service.‖
         • Are there similar state statutory or regulatory limitations?



8
Inclusion of Broadband – Federal Debate
    • Mandate as condition for receipt of USF funding - Embarq
     Proposal
        • Broadband and Carrier-of-Last Resort Support (BCS)
        • Proposes to replace the Non-Rural High-Cost Model and
          High-Cost Loop support in price cap areas with new
          mechanism (BCS) based on wire centers.
        • BCS recipients would make 3 commitments:
            –Offer broadband of at least 1.5 MBPS downstream to at least
             85% of customers in the wire center;
            –Provide supported local service at rates based on list of urban
             rates in the FCC‘s reference book of Rates, Price Indices and
             Household Expenditures;
            –Build-out and serve entire wire center using only their own
             facilities within 5 years.


9
Goals of State USFs
•    Can/Should they evolve to include Broadband or other PANs (pretty
     amazing new stuff)?
      • States may adopt additional specific, predictable and sufficient
        mechanisms to preserve and advance universal service so long
        as they do not burden federal universal service support
        mechanisms.
      • Every telecom carrier providing intrastate telecom services must
        contribute on an equitable and nondiscriminatory basis.
      • State USFs include:
            • High cost funds
            • Low-income programs
            • State subsidy programs for schools and libraries, rural health care
              facilities
            • State subsidy program for advanced telecom services



10
Principles and Lessons Learned:
The Need for Accountability and Oversight

•    Texas
•    Size of Fund: High Cost alone is $395M
•    2008 reform resulted from a Legislative mandate to re-examine a
     program that has provided more than $3B in public subsidy since
     2002 and what changes needed to be made to reflect price
     deregulation of more than 75% of Texas exchanges.
      • Reduced the USF assessment from 4.4% to 3.4%.
      • Reduced the Large Carrier USF subsidy by $144 Million annually
      • Eliminated subsidies for exchanges where price deregulation has
        occurred.
      • Instituted additional reporting requirements to make the fund
        more transparent to the PUC and public.




11
Principles and Lessons Learned:
The Need for Accountability and Oversight

• Texas
     • Requirement that funds be spent in a manner consistent
       with the purposes of USF, but no requirement that the
       money be spend in exchanges that it is ear-marked for.
     • The Legislature concluded that the largest component of
       the fund (fund supporting large ILECs) lacked detailed
       accounting, concluding ―… it is impossible to determinate
       [sic] definitively whether of not receipts for high-cost
       support were spent for intended purposes in high-cost wire
       centers.‖




12
Principles and Lessons Learned –
Effectiveness of Programs
     A Case Study – Wisconsin - $ 32M Fund – becoming a $45M fund

PSC Administered funds: $6 Million                            Non PSC Administered Funds: $26M
      High Rate Assistance Credit – partial credit of         •   TEACH/DOA Program:
          local telephone rate
                                                                    • Educational Telecommunications Access –
      Telecommunications Equipment Purchase                            subsidized access to new data lines for direct
          Program – financial assistance for persons                   Internet access and two-way interactive video
          with disabilities                                            links
      Lifeline – (low income) support for basic local         •   DPI Programs:
          service
                                                                    • Newsline – funds a contract with the National
      Link-Up America – (low income) waives certain                    Federation of the Blind to provide access to
          charges associated with establishing or                      audio versions of major national newspapers
          moving telephone service.
                                                                    • BadgerLink – funds a contract with vendors
      Rate-Shock Mitigation – rate credits for customers               that provide statewide access to reference
          to temporarily mitigate the effect of large                  databases of magazines and newspapers
          increases in authorized telephone rates                      through BadgerLink
      Access Program or Project by Nonprofit Groups –               • Supplemental Aid to Public Library Systems –
          funding to nonprofits to facilitate the provision            funds aid payments to public library systems.
          of affordable access to telecommunications
          and information services                            •   UW System Program:
      Medical Telecommunications Equipment – grants                 • UW System BadgerNet Access – BadgerNet
          to nonprofit medical/health organizations for                access support for UW campuses
          purchase of telecom equipment
      Public Interest Pay Telephone – payments to
          telephone companies to make available public
          pay phone services in specific areas
      Two-Line Voice Carryover – waives charges for a
          second telephone line used by hearing-
          impaired customers for teletype service



13
Principles and Lessons Learned –
Effectiveness of Programs
Wisconsin – Case Study
    • There are audits that examine whether the funds have
       been used, but not how effective the programs are.
           • Are these programs still needed?
           • Are these programs well managed?
           • Are there opportunities for efficiency?
Lessons Learned:
     • Needs may change (BadgerLink replaced by Google, Public Interest
       Payphone replaced by cell phones, Educational Telecom Access
       replaced by Broadband efforts)
     • access lines and usage may decline
     • but USF lives forever
     • Hard to eliminate a subsidy once the recipient is used to receiving it.
Implication for Broadband:
     • Do you create a new fund that may be short-lived but
       funding/contribution and pay-outs have no end point? How do you judge
       when the program has been effective and phase out support?


14
Principles and Lessons Learned –
competitive neutrality
•    The assessment should be levied upon telecom providers (and their
     end users) in a competitively and technology neutral manner.
       • Blending and consolidation of telecommunications, broadband,
          data, internet and IP-based services is challenging the long-term
          distinctions applied to rates, taxes and fees charged by various
          entities and organizations.
       • Certain newer technologies or market participants should NOT
          be given special treatment and exempted from or required to pay
          different rates, taxes or fees.
•    Example: Wisconsin USF contributors include: ILEC, CLEC, Cable
     (if obtained certificate as telecom provider).
      • Wireless and VOIP Providers do not contribute
      • Wireless providers can be a recipient of Wisconsin USF



15
 WI Intrastate USF Revenues are falling – putting more
of a burden on wireline carriers (wireless exempt)


                  Wisconsin Intrastate USF Assessable Revenues
            2.3

            2.2
$ Billion




            2.1

            2.0

            1.9

            1.8

            1.7
            1.6
                       2000   2001      2002        2003        2004        2005   2006

16
                                 Source: Public Service Commission of Wisconsin
     While Wisconsin State USF Assessments Are Growing –
     Competitive Disparity for Wireline Companies (wireless
     exempt)

                       Demand On Universal Service Fund Dollars

                  40
                  38
                  36
                  34
                  32
                  30
      $ Million




                  28
                  26
                  24
                  22
                  20
                  18
                  16
                       2001-02    2002-03     2003-04      2004-05      2005-06      2006-07     2007-08    2008-09
                   Sources: 2001 Wisconsin Act 16; 2003 Wisconsin Act 16; 2005 Wisconsin Act 25, 2007 Wisconsin Act 20
                                                        Budget Years

17
Principles and Lessons Learned –
competitive neutrality
•    Lessons Learned:
       • Exempting one whole class of carriers skews competitive choices
       • Providers that don‘t pay into the fund will be able to price their products
         at less cost to the consumer, all other things being equal.
•    Implications for Broadband: Not all broadband providers contribute to
     Federal or State USF today (VOIP, Cable). Should they?
       • Legal Issues at the state level for VOIP assessments.
             • FCC Amicus Brief – FCC has not preempted states from assessing USF
               fees on providers of interconnected VOIP service
             • Vonage 8th Circuit decision – states can‘t assess nomadic VOIP service
               providers.
      • If company does not contribute, shouldn‘t be eligible to receive funds.
             • Does this favor one type of technology over another?
             • Where does broadband over power line and other new services/providers
               fit?




18
Principles and Lessons Learned:
Need-Based Expansion Consistent with Goals
•    State USF funds are easily diverted to other non-USF purposes:
      • Wisconsin – Governor removed from the general budget $12.6M
        per year to fund the public library system and directed it be
        funded out of the USF
           • Will increase the USF assessment and end users will see an
             increase on the phone bill for this additional ‗tax‘
           • Public library system support is not USF related (funding is not
             limited to only broadband internet access)
•    State USF Funds Should not be Expanded to Recover Competitive
     Losses
      • Two Indiana RLECs sought recovery from the Indiana USF to
        offset revenue lost ($620,000 annually) from reductions they
        made in their local service rates to respond to increasing
        competition and improve customer satisfaction. Carriers (AT&T
        and tw telecom) opposed it and the IURC denied the relief.
•    State USFs should not provide subsidies in a deregulated
     environment. A simple rule – no subsidy for deregulated services –
     substantially reduces subsidy funds.

19
Principles and Lessons Learned:
Need-Based Expansion Consistent with Goals
•    Watch out for ‗tax‘ impact:
      • Federal, state and local taxes on telecom users average 16.87%,
        2-3 times as high as the average sales tax. (2007 Heartland
        Institute – ―Taxes and Fees on Communications Services.‖)
      • Average Monthly taxes and fees by Average Subscribers to
        Wireline Telephone Service
           29.24% - Dallas, TX            16.02% - Bismarck, ND
           29.10% - Kansas City, MO       15.27% - Sioux Falls, SD
           27.78% - Chicago, IL           14.32% - Des Moines, IA
           24.23% - Omaha, NE             12.35% - Indianapolis, IN
           22.06% - Wichita, KS           10.95% - Milwaukee, WI
           19.89% - Little Rock, AR       9.67% - Lansing, MI

      • Taxing telecom services is regressive, stymies technological
        progress by creating disincentives to purchase services.


20
Principles and Lessons Learned:
Need-Based Expansion Consistent with Goals
•    Watch out for ‗tax‘ impact:
      • Example from a large, multi-state, customer:
       •   Do you want to add more to this bill?




21
Should State USFs Evolve to Include
Broadband?
Options:
      • Wait and See Impact of Federal Broadband Grants
      • Wait and See Revisions to Federal USF
If Broadband is added to State USFs, the program/fund must have:
      • Clear Goals and Objectives with an End Date/Phase Out
      • System of Oversight and Accountability for Use of Funds
      • Regular Assessment of Effectiveness of programs
      • Competitive neutrality for both assessments and distributions
      • Narrowly tailored and targeted funding relief given the financial burden
        on end-users
Increasing deployment of robust broadband to the business sector will
   be an economic driver for the US economy
     • Spur competition for broadband services, increasing innovation
       and lowering prices
     • Require, where necessary, access to ILEC facilities at just and
       reasonable prices



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