1. Modernizing Universal Service Dennis Weller Chief Economist VerizonNARUC Summer Meetings July 2007

2. Page 2 The World Has Changed New competition, technology Large companies forced to reinvent themselves Change now coming to high cost areas Lines, minutes declining CETCs in two thirds of study areas “Hollowing out” old business model Challenge for universal service How to modernize the system for the future Adaptation, efficiency, market forces

3. Page 3 The Current Funds Designed to Support the Status Quo Different funds created over time to plug ILEC revenue shortfalls Pays companies for what they are already doing Rewards companies for having higher costs Does not help companies adapt to the new environment

4. Page 4 The Current Funds Adapting to Wireless Wireless service is good Competition is good But the funds were not properly designed for either Attracts CETCs to areas where ILEC subsidies are high Pays CETCs to do what they would have done anyway Pays for handsets, not for extending service 98% of areas where subsidized wireless service is available also have wireless service available from unsubsidized carriers

5. Page 5 The Current Funds Adapting to Wireless – the Hard Math Wireline service is bought per household Wireless service is bought per family member We now pay the same amount per handset as per wired line Average number of handsets per family plan: 2.8 End game if we convert wireless to subsidized model: –$3B (current ILEC) + $8.4B ($3B x 2.8) = $11.4B –Contribution factor about 23% with today’s base

6. Page 6 Why an Auction? Competitive bidding is the normal way for government to buy products and services Selects the most efficient provider Ensures the best terms for the public Transparent, open process Brings market forces to bear on universal service The only way to answer the question: “What does universal service cost?” Which also is the answer to the question: “What support is sufficient?” It’s not possible to answer these questions by looking at carrier’s costs

7. Page 7 Verizon’s proposal to Modernize Universal Service Step 1: Stabilize the fund on an interim basis –Joint Board has proposed interim cap Step 2: Adopt a framework for competitive bidding Step 3: Auctions where there is more than one ETC –Results in one wireline, one wireless universal service provider in each area Step 4: Review and next steps –Extend auctions more widely? –One universal service provider per area?

8. Page 8 New Demands on the Funds Better targeting of support where it’s needed Areas that are not supported today Areas that don’t have wireless today Areas that don’t have broadband today How to address these demands without –Ballooning the fund –Robbing Peter to pay Paul Efficiency is the key

9. Page 9 Using Savings from Efficiency Gains To Pay for New Needs Establish zones within study areas Initial auctions generate savings Savings used to: –Reduce burden on consumers –Target funding to new needs Prioritize areas based on statistical analysis of auction results Open areas for nomination by carriers –Wireline where no support today –Wireless where no service today Competitive bidding for each area –FCC works down prioritized list until available funds have been distributed

10. Page 10 What About Broadband? What about broadband?

11. Page 11 Household Internet Adoption Percentage of Households Taking Broadband US Average: 42% EU Average: 23% NVNJDKCACTDEAZMAUTFLWAGANHNYSEMDVACOIDWYTXOHILNEORNDNCMOPANMWIRISCLAMIMNSDTNIAALAROKMEINMTKYVTMSWVUKNLKSFIBEFREEMTLUATSIDEESLVPLPTITHUCZLTCYIESKEL US States & EU Member Countries Data from household surveys taken in late 2005 and early 2006. Sources: European Commission, “E-Communications Household Survey,” July 2006; US average from Pew Internet & American Life Project, “Home Broadband Adoption 2006”, May 28, 2006; US states from Render Vanderslice & Associates, September 2006

12. Cap-Ex of US Companies and OECD Telecoms Source: Yahoo Finance data Year Ending Sept./Dec. Page 12

13. Page 13 Extending Broadband Availability How can we do better in getting broadband where it isn’t? Broadband is too important to be included in the universal service mechanism – USF system is already broken – Not targeted or efficient – No other country does it this way Success of the public-private partnership model – Data gathering and use of the data should be integrated – Micro data are best gathered locally – Connect Kentucky Various means for bringing investment where need is identified – Demand development – Tax and other incentives, existing funding sources – Participation by public and private entities in community

14. Page 14 Extending Broadband Availability How can Federal Policy help? Federal funding to encourage other states to adopt public-private partnership model – Connected Nation – Proposals for reform of RUS Enhancing the “tool kit” – Tax incentives, loans State public-private partnerships as a “farm system” to identify projects for additional federal funding through grants – For extreme cases where the normal “tool kit” is not sufficient – Grants for infrastructure deployment – RUS or some other federal agency – Nomination for federal funding would lead to open, competitive bidding