1. Different approaches before and after Telecom Act Before Telecom Act –Implicit cross subsidies –Based on rate of return approach –ILECs only receivers/IXCs only payers After Telecom Act –Explicit subsidy payments –Based on economic costs (except for small ILECs) –ILECs and CLECs receivers/all providers payers

2. Different types of LECs Large ILECs (including RBOCs) –New Cost Proxy Model –CALLS plan Small ILECs (mostly rural) –Actual costs (no Cost Proxy Model) –Continuation of former support programs –Part of the MAGS plan CLECs –Depends on the status of the ILEC with whom they compete

3. The Loop Cost recovery: 75% from state and local 25% from interstate --SLC and CCLC (unless you are a small high cost ILEC)

4. The Switch Cost recovery: weighted DEM from interstate jurisdiction for small ILECs (under 50,000 lines, usually “Ma and Pa” local telcos)

5. Before Telecom Act of 96 Universal service support paid by –IXCs (based on presubscribed lines) LifeLine and LinkUp Universal service fund –LECs (who left the CCLC pool) Long term support

6. High Cost Loops Universal Service Fund (former USF) –Support for loops in excess of average loop cost Small company: 65% of amount between 115%--150%; 75% of amount over 150% Larger company: 10% of amount between 115%--160%; 30% of amount between 160%--200%; 60% of amount between 200%-- 250%; 75% of amount over 250% –Based on national average of actual loop costs of all ILECs –Before breakup of AT&T—recovered through intra-company cost shifting—no need for separate fund –Before end of NECA CCLC pool—recovered through NECA pool—no need for separate fund –Before Telecom Act of 1996—fund paid into only by the IXCs; payments made only to ILECs

7. Averaged CCLC Long term support payments –Paid by ILECs who left the CCLC pool –Paid into the CCLC pool so that averaged CCLC would be charged by the smaller high cost companies –Support received by ILECs in the CCLC pool

8. Example Average-to-low cost LEC: –Loop cost covered by Interstate jurisdiction (25%) –SLC and CCLC State jurisdiction (75%) –State access charges –Contribution from intraLATA long distance –Local service charges

9. Example High cost LEC –Loop cost covered by Interstate jurisdiction –SLC and CCLC –Long term support –Universal service fund State jurisdiction –State access charges –Contribution from intraLATA long distance –Local service charges

10. Weighted DEM Recovered by small (under 50,000 line) companies through: –Access charges (specifically local switching rates) if filed own tariff –NECA switched access pool if participated in NECA pools Paid by IXCs through access charges

11. After the Telecom Act Telecom Act adds new categories to the list –Schools and libraries –Rural health care providers Telecom Act continues LifeLine and LinkUp Telecom Act injects competition into universal service –Eligible Telecommunications Carrier

12. The challenge Non-discriminatory, pro-competitive high cost support –Whose costs do you use? ILECs? CLECs? –What costs reflect competitive rather than monopoly marketplace? The answer: a Cost Proxy Model

13. The cost proxy model approach Calculate nationally averaged forward-looking cost per line: $21.92 Establish benchmark for support: 135% of national average, or $29.59 Calculate state averages—only for non-rural carriers For states that exceed the benchmark, multiply the amount over$29.50 by 76%--multiply the result by number of lines served and that is support for the state; if state average is below $29.59, no support for that state Federal support is targeted to the highest cost wire centers in that state

14. Issues with the proxy model Lots of arguments over the inputs Huge shifts in subsides among states –Maine ILECs got no support under old system; get $10.2 million under proxy model; California ILECs got $6.3 million under old system, get nothing under proxy model –Hold harmless provision – phased out $1 per line per year Applied only to the non-rural carriers—small “Ma and Pa” companies stay under old system and even get more support if show growth in lines or more investment

15. So what do we have now? One fund, called a Universal Service Fund, that includes payments for a host of universal service programs Paid into by all telecommunications carriers (still at 7.2805% of interstate revenues) Funds received by a host of entities, including ILECs, CLECs.

16. What’s in the fund? Low Income Support Programs (4 th quarter of 2002) –Lifeline: $172 million –LinkUp America: $8 million –Toll Limitation: $1 million Rural health care support (capped at $400 million annually)--$22.5 million Schools and Libraries support (capped at $2.25 billion annually--$565.2 million for 4 th quarter 2002

17. What’s in the fund? High cost program –Continuation of old support programs High cost loop--Continuation of former USF fund (annual support for rural carriers $1 billion) Local switching support (DEM)—total annual support of $402 million Long term support—for participants of NECA CCLC pool--$498 million annual support –New support programs Interstate access support--created by CALLS plan and capped at $640 million annually Interstate common line support—created by MAGS plan and currently $370 million in annual support Non-rural forward looking cost support (from Proxy Models) –Non-rural carriers in 8 states ($58 Million in 4 th quarter 2002) –Non-rural carriers in 6 states get interim hold-harmless support ($30 million in 4 th quarter 2002)

18. So what are the controversial issues? Some carriers make money on their contribution—owe the fund 7.2805% but collect as much as 11% from consumers Who is eligible to be an ETC? How are the schools and libraries using their support? Cable modem providers, VoIP providers don’t pay into the fund—unfair advantage? Base for the USF is shrinking, so the contribution percentage keeps going up—FCC looking for different basis for collecting funds—for example, based on number of customers instead of revenues