We know your network.

But we also know your name

We know your network.

But we also know your name

State Universal Service Funds:Evolution to Broadband?

Pamela SherwoodMARC June 15, 2009

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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.

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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:

Level 3 Communications, Inc.NuvoxOne CommunicationsPaeTec, Inc./McLeodUSA, Inc.Socket Telecom, LLCtw telecom inc.TDS Metrocom LLC* XO Communications, Inc.360networks (USA) Inc

Access Point, Inc.Birch CommunicationsCavalier TelephoneCBeyond Communications, LLCCIMCO CommunicationsCovad Communications CompanyData Net Systems, LLCGlobalcom, Inc. / First Communications, Inc.

Access Point, Inc.Birch CommunicationsCavalier TelephoneCBeyond Communications, LLCCIMCO CommunicationsCovad Communications CompanyData Net Systems, LLCGlobalcom, Inc. / First Communications, Inc. Not all MACC members agree with the

positions presented hereNot all MACC members agree with the positions presented here

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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

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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?

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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

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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.

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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?

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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.

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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

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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.

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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.”

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Principles and Lessons Learned – Effectiveness of Programs

PSC Administered funds: $6 MillionHigh Rate Assistance Credit – partial credit of

local telephone rateTelecommunications Equipment Purchase

Program – financial assistance for persons with disabilities

Lifeline – (low income) support for basic local service

Link-Up America – (low income) waives certain charges associated with establishing or moving telephone service.

Rate-Shock Mitigation – rate credits for customers to temporarily mitigate the effect of large increases in authorized telephone rates

Access Program or Project by Nonprofit Groups – funding to nonprofits to facilitate the provision of affordable access to telecommunications and information services

Medical Telecommunications Equipment – grants to nonprofit medical/health organizations for 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

Non PSC Administered Funds: $26M• TEACH/DOA Program:

• Educational Telecommunications Access – subsidized access to new data lines for direct Internet access and two-way interactive video links

• DPI Programs:• Newsline – funds a contract with the National

Federation of the Blind to provide access to audio versions of major national newspapers

• BadgerLink – funds a contract with vendors that provide statewide access to reference databases of magazines and newspapers through BadgerLink

• Supplemental Aid to Public Library Systems – funds aid payments to public library systems.

• UW System Program:• UW System BadgerNet Access – BadgerNet

access support for UW campuses

A Case Study – Wisconsin - $ 32M Fund – becoming a $45M fund A Case Study – Wisconsin - $ 32M Fund – becoming a $45M fund

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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?

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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

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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

2.1

2.0

1.9

1.8

1.7

1.6

$ B

illi

on

2000 2001 2002 2003 2004 2005

Source: Public Service Commission of Wisconsin

2006

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While Wisconsin State USF Assessments Are Growing – Competitive Disparity for Wireline Companies (wireless exempt)

Demand On Universal Service Fund Dollars

Sources: 2001 Wisconsin Act 16; 2003 Wisconsin Act 16; 2005 Wisconsin Act 25, 2007 Wisconsin Act 20

40

38

36

34

32

30

28

26

24

22

20

18

16

$ M

illi

on

2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

Budget Years

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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?

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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.

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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, ND29.10% - Kansas City, MO 15.27% - Sioux Falls, SD27.78% - Chicago, IL 14.32% - Des Moines, IA24.23% - Omaha, NE 12.35% - Indianapolis, IN 22.06% - Wichita, KS 10.95% - Milwaukee, WI19.89% - Little Rock, AR 9.67% - Lansing, MI

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

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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?

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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-usersIncreasing 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