In the Matter of		)
				)	CC Docket No. 96-45	
Federal-State Joint Board on	)
Universal Service		)

COMMENTS OF

MFS COMMUNICATIONS COMPANY, INC.

Andrew D. Lipman
Mark Sievers

SWIDLER & BERLIN, CHARTERED
3000 K Street, N.W., Suite 300
Washington, D.C. 20007
(202) 424-7500

Attorneys for
MFS COMMUNICATIONS
COMPANY, INC.

Dated: April 12, 1996

COMMENTS OF
MFS COMMUNICATIONS COMPANY, INC.

Table of Contents

SUMMARY ii

INTRODUCTION 1

I. GOALS AND PRINCIPLES OF UNIVERSAL SERVICE SUPPORT MECHANISMS 2

A. Competition Preserves and Advances Universal Service so Subsidies Should be Provided only in Extraordinary Circumstances 2
1. Competition reduces prices and increases the
value of telephone service 4
2. Competition has not harmed incumbent providers 4
3. The "myth" that local rates must be subsidized is not true 5
B. Universal Service Support Should Not be Used to Guarantee Incumbent Firm Revenues and Should Not be Based on Incumbent Firm Costs 7
C. Universal Service Support Must Be Explicit, Specific, Predictable and Sufficient and Administered by an Independent Entity 9
D. Universal Service Support Must be Targeted, Competitively Neutral, and Portable Among Competitors 13

II. SUPPORT FOR RURAL, INSULAR, AND HIGH-COST AREAS AND LOW-INCOME CONSUMERS 16

A. Only Basic Local Telephone Service in High-Cost Areas or Provided to Low Income Customers Should be Included Among Potentially Subsidized Services 16
B. Determining the Size of the Universal Service Fund 17

III. SCHOOLS, LIBRARIES, AND HEALTH CARE PROVIDERS 20

IV. OTHER UNIVERSAL SERVICE SUPPORT MECHANISMS 21

V. ADMINISTRATION OF SUPPORT MECHANISMS 23

VI. CONCLUSIONS 25

ATTACHMENT Local Telephone Competition and the "$20 Billion Subsidy": What it Really Means and What to do about it

SUMMARY

As a long time proponent of universal service reform, MFS enthusiastically supports the Commission and Joint-Board's efforts to resolve the issues that stymie competition under the guise of "universal service." As the Commission and Joint-Board develop the Nation's universal service policies, such policies should recognize:

1. Competition preserves and advances universal service so universal service subsidies should be provided only in extraordinary circumstances;

2. Universal service support should not be used to guarantee an incumbent's revenues or earnings and should not be based on an incumbent's costs or revenue requirements;

3. Universal service support, if any, should be explicit, specific, predictable and sufficient and administered by an independent entity; and,

4. Universal service support should be narrowly targeted to individuals who could not afford telephone services without assistance, competitively neutral and portable.

The Commission and Joint-Board should retain the universal service support mechanisms that are targeted to individuals, specifically Lifeline, Link Up and TRS support. High-cost support mechanisms (USF, DEM weighing and LTS) should be replaced with a high-cost support mechanism that is based on the forward-looking costs of an efficient competitor at a level of disaggregation, like census blocks, much smaller than the state study areas used today. High-cost support should be no larger than is presently provided. As a starting point, support should be limited to areas with with costs greater than 130% of the national average and household incomes less than 130% of the national average.

The Telecommunications Act requires that the Commission establish discounted access to the services comprising universal service for schools and libraries. However, discounting the price of basic local telephone service will likely have little impact on schools' and libraries' use of the Internet since the price of telecommunications is small relative to the cost of computer hardware and software used for Internet access. The Commission can best encourage deployment of advanced telecommunications services to schools, libraries and health care providers by encouraging the development of local telephone competition.

The recovery of NTS costs results in a mismatch between CCL revenues and loop costs that historically yielded a windfall for incumbent local exchange carriers that is not targeted to low income consumers and high-cost areas. Preserving the windfall is not essential to the promotion, preservation or maintenance of universal service. The Commission should eliminate the CCL and, as necessary, transfer recovery of NTS costs to end-user customers.

The Commission should exempt carriers with less than a 1% market share from providing universal service support, and should require only common carriers to contribute to universal service support. Contributions to universal service support should be based on telecommunications carriers' common carrier revenues less payments to intermediaries. The universal service fund should be administered by an independent non-governmental agency that has no competitive interest in who receives or who provides universal service support.

Before the
FEDERAL COMMUNICATIONS COMMISSION
Washington, D.C. 20054

In the Matter of		)
				)	CC Docket No. 96-45	
Federal-State Joint Board on	)
Universal Service		)

MFS Communications Company, Inc. ("MFS"), by its undersigned counsel and pursuant to Section 1.415 of the Commission's rules, submits these comments in response to the Commission's Notice of Proposed Rulemaking and Order Establishing a Joint Board in the above captioned proceeding.

INTRODUCTION

MFS enthusiastically supports the Commission and Joint-Board's efforts to address and resolve many of the issues that stymie competition under the guise of "universal service." MFS is a long-time proponent of reform of universal service support mechanisms. In 1993, MFS filed a Petition for Notice of Inquiry and En Banc Hearing[1] with the Commission that advocated many of the universal service reform principles embodied in the Telecommunications Act of 1996[2] and this rulemaking. Since many of the principles are unchanged, MFS offers Attachment 1 to these comments as a concise statement of the universal service policy principles MFS continues to support. Attachment 1 is the same attachment MFS filed with its universal service petition in 1993.

In this filing, MFS follows the general outline of the Notice in offering its comments on the various issues raised in the above captioned rulemaking.

I. GOALS AND PRINCIPLES OF UNIVERSAL SERVICE SUPPORT MECHANISMS

The Telecommunications Act directs the Commission and the Federal-State Joint Board ("Joint Board") to recommend changes to any of the Commission's regulations based on "policies for the preservation and advancement of universal service."[3] As the Commission and the Joint-Board develop the Nation's universal service policies, such policies should recognize:

1. Competition preserves and advances universal service so universal service subsidies should be provided only in extraordinary circumstances;

2. Universal service support should not be used to guarantee an incumbent's revenues or earnings and should not be based on an incumbent's costs or revenue requirements;

3. Universal service support, if any, should be explicit, specific, predictable and sufficient and administered by an independent entity; and,

4. Universal service support should be narrowly targeted to individuals who could not afford telephone services without assistance, competitively neutral and portable.

A. Competition Preserves and Advances Universal Service so Subsidies Should be Provided only in Extraordinary Circumstances

As the Commission and Joint Board develop universal service policies, they should presume that opening markets to competition will preserve and advance universal service and implement universal service subsidies only in extraordinary circumstances. Historically, as competition came to various telecommunications markets, opponents of such competition raised the spectre of a threat to universal service to stymie opening "their" markets to competition. However, in spite of incumbent firms' dire predictions, competition in telecommunications markets has never proven to be harmful to universal service. Telephone subscribership is at historic high levels and U.S. subscribership is far higher than in countries where telecommunications services are provided in a non-competitive market structure. Clearly, the telecommunications market is unambiguously more competitive today than it was 20 years ago, and the U.S. telecommunications market is far more competitive than the majority of foreign markets.[4] In its recent survey of universal service support mechanisms, the Commission Staff summarized the role of competition in promoting universal service.

New entrants in local telecommunications markets have strong incentives to develop and implement cost-efficient technology, creating pressure for the incumbent service provider to lower prices and improve service capabilities. Effective local service competition thus can promote universal service by stimulating technological advancement, lower prices, and marketing innovation. The Commission has already observed that prices are lower in cable television markets subject to competition and expects the entry of competitive access providers to lead to lower access prices in telephone markets.[5]

As the Commission and the Joint Board develop universal service policies, they should not fall victim to the Cassandras who claim that competition threatens universal service. In fact, competition promotes universal service for several reasons.

1. Competition reduces prices and increases the value of telephone service.

Competition in many telecommunications markets has proven to provide powerful incentives to reduce prices, which stimulate demand for service. Likewise, competition encourages firms to be more responsive to customers' demands and to develop new products or services that enhance the value of telecommunications services and stimulate demand.[6] It is economically irrational for providers in an effectively competitive market to raise prices to unaffordable levels, degrade service quality or otherwise drive customers off their networks.

2. Competition has not harmed incumbent providers.

There are many examples of how competition has benefited incumbents rather than harmed them. At divestiture, AT&T served nearly all of the long distance marketplace. More than a decade later, AT&T has lost more than 30% of its market share and reduced its prices more than 40%, yet its revenues and earnings today are higher than they were at divestiture. Competition created incentives for AT&T to streamline its operations, reduce its costs, become more responsive to customers, and stimulate the market with a variety of new services and promotions. It is reasonable to believe that incumbent local exchange carriers will respond to competition in exactly the same way. Just as no subsidies were required to assure the universal availability and affordability of long distance services in a competitive market, subsidies should not be required in a competitive local telephone market.

While they have not been subject to the same competitive intensity as AT&T, the largest incumbent local exchange carriers are financially better off today than they were a decade ago in spite of the introduction of competition in "their" markets. Since 1987, the Commission's reports indicate that state regulators, often as a reaction to overearnings by incumbent local exchange carriers, have reduced incumbent local exchange carrier annual revenue requirements by about $5.1 billion.[7] These multi-billion dollar regulator-mandated revenue reductions are stark evidence that competition has not harmed incumbent local telephone companies nor has it threatened universal service. In fact, at a recent investment conference, NYNEX's chief executive, Ivan Seidenberg predicted that NYNEX's revenues would double from $13.7 billion in 1995 to between $25 and $27 billion by 2003-2005 in spite of a predicted market share loss of 30-35% over the next five to seven years. Seidenberg told investors "What is lost to competitors is made up for in new growth."[8]

In short, as the Commission and the Joint-Board develop universal service policies they should not view competition as a universal service problem to fixed, but rather, as an ally in the preservation and advancement of universal service.

3. The "myth" that local rates must be subsidized is not true.

A common "myth" of the telephone industry is that local telephone service is priced below costs, and that such below cost pricing is necessary to ensure that consumers will subscribe to telephone service. The "myth" concludes that local telephone companies need to preserve subsidies in order to preserve below cost local telephone service, which is threatened by competitors who drive out internal cross-subsidies by targeting high-margin, subsidy generating market segments. Local telephone company revenues are often described like a balloon -- if competition squeezes the revenue balloon at one end, the local ratepayer end of the balloon must expand to recoup the losses. The myth is utterly untrue and perpetuated by incumbent firms that seek government protection to restrict competition in the markets they dominate. The Commission and Joint-Board should be aware of the myriad of fundamental flaws in this "myth."

Local telephone costs will be lower in a competitive marketplace. Universal service support programs should not be based on incumbent carriers' revenue requirements or costs, but rather, should look to the costs of an efficient, market-driven competitive provider. In an effectively competitive local exchange market, firms have powerful economic incentives to reduce their costs and become more efficient. No one knows what it really costs to provide local telephone service in a competitive market because there has never been effective local telephone competition to create the economic incentives for incumbent telephone companies to reduce costs and improve efficiency. In a competitive environment, the prices that incumbent carriers assert are below cost and need to be subsidized may well prove to be profitable.

Individual service prices in a competitive marketplace providing bundled services may be below cost. In a competitive marketplace, it may be economically sensible to offer services below cost in two instances: (1) when a firm adds telephone service to an existing product line; and, (2) in order to have the opportunity to sell more profitable services to customers. As the Commission Staff described in its Universal Service Survey, new entrants may be adding local telephone service to cable television service, electric utility service, or adjoining local exchange services.[9] In such circumstances, adding local telephone service may cost far less than the stand-alone costs of incumbent local telephone company. Since competition will drive costs to the level of the most efficient provider, universal service funding should be based on the lower of the costs irrespective of the incumbent's embedded stand-alone costs.

Also, a vertically integrated firm may offer local telephone service at or below cost for the opportunity to market and bundle long distance services, vertical services, information services, video services, and/or telephone equipment with the "subsidized" local telephone service. In the competitive wireless industry, for example, cellular providers often give away or sell for a nominal amount cellular phones costing hundreds of dollars in order to have the opportunity to market other telecommunications services to customers. In an interview in Wired, Bell Atlantic's chief executive officer, Raymond Smith applied this same pricing principle to telephone service when he predicted, "I can envision one day offering various packages of services. And one of them might be a package of video and interactive services in which the customer also gets phone service for another two or three bucks."[10] Obviously, it is not sensible public policy to develop universal service support programs to subsidize such market-driven below cost offerings.

B. Universal Service Support Should Not be Used to Guarantee Incumbent Firm Revenues and Should Not be Based on Incumbent Firm Costs

Universal service should not be a mechanism to preserve incumbent local exchange carrier revenues or earnings. Plainly, the legislative intent of the Telecommunications Act is "to provide for a pro-competitive, de-regulatory national policy ... opening all telecommunications markets to competition."[11] In a competitive environment, a firm's revenues and earnings depend entirely on its entreprenuerial efforts. A competitive firm's revenues and earnings are not guaranteed by payments from competitors. In the television industry, for example, Zenith has no right to receive payments from Sony to recoup competitive losses, guarantee Zenith's revenues or maintain a particular return. Universal service funding designed to maintain incumbent local exchange carrier revenues or earnings is utterly contrary to the pro-competitive intent of the Telecommunications Act and should be rejected.

Universal service support should also be independent of the incumbent firm's costs and revenues. As the Commission has discussed in prior universal service inquiries, support mechanisms, such as the Universal Service Fund ("USF"), that are based on the incumbent firm's revenue requirements distort incentives for incumbents to reduce their costs and become more efficient.[12] As noted above, in a competitive environment, firms have incentives to reduce costs, so the incumbent's costs arguably provide no information about the costs of providing service in a competitive market. Also, the incumbent's costs are based on a particular technology, which may not be the technology used by competitors in a competitive environment. To the extent that universal service support is required, it should be based on an independent estimate of the incremental costs to provide service to specific areas. Said differently, universal service support should be based on the additional costs that an efficient competitor using a forwarding-looking technology would incur by adding local telephone service to its product line, and not based on the embedded costs or embedded technologies of incumbent service providers.

For example, the Hatfield study which was commissioned by MCI to develop estimates of the costs of local telephone service found that wireless technologies can provide service at costs that are $25 a month lower than wireline technologies in areas with very low population density, which tend to be considered high cost areas.[13] Likewise, in a competitive local service environment, cable television companies, electric utility companies and satellite technologies may provide lower cost alternatives that the traditional wireline services provided by incumbent local exchange carriers.

C. Universal Service Support Must Be Explicit, Specific, Predictable and Sufficient and Administered by an Independent Entity

Universal service support should be explicit and well defined rather than buried in a Byzantine system of cross-subsidies that distort markets, hide costs and paralyze policy makers for fear that any action threatens universal service. Today's universal service support system is a giant "fuzzball" that hides costs, distorts competition, and yields economically irrational prices. The Telecommunications Act requires that any universal service support be explicit,[14] "specific, predictable and sufficient"[15] and collected from every interstate telecommunications carrier on an "equitable and nondiscriminatory basis."[16] The conference committee report clearly indicates that Congress intended that any universal service support be explict.

To the extent possible, the conferees intend that any support mechanisms continued or created under new section 254 should be explicit, rather than implicit as many support mechanisms are today.[17]

It is widely recognized that many telecommunications prices contain substantial levels of contribution that incumbent local exchange carriers often claim is necessary for the support of universal service.[18] The Commission's Notice and the Staff's Universal Service Survey cataloged a variety of implicit and explicit suppport mechanisms, including:

_ High Cost Support, including the Universal Service Fund ("USF") and Dial Equipment Minute ("DEM") weighting for smaller carriers in high-cost service areas,[19]

_ Low Income Support, including Lifeline and Link Up programs,[20]

_ Local Loop Support, including recovery of the interstate allocation of loop costs through a combination of subscriber line charges ("SLCs") paid by end-users and carrier common line ("CCL") charges paid by long distance carriers;[21]

_ Long Term Support ("LTS") paid by larger local exchange carriers;[22]

_ Rural Telephone Company Support comprised of subsidized loan programs;[23]

_ Telecommunications Relay Service ("TRS") Support for hearing impaired telecommunications users;[24]

_ Geographically Averaged Rates creating an implicit subsidy from low-cost areas to high-cost areas.[25]

_ Transport Rate Structure Support including the residual interconnection charge ("RIC") associated with the restructure of local transport charges, which is a subsidy (but, obviously, the RIC is not intended to support local service) since it is a charge that has no basis in costs or the marketplace but is merely intended to maintain incumbent local exchange carriers' pre-restructure transport revenues;[26]

In addition to the subsidies identified by the Commission and the Staff,

_ USTA Subsidy. In a widely circulated study, USTA argued that the contribution or subsidies in telecommunications prices at risk of loss to competition amount to $20 billion annually and represented the subsidy to be the difference between prices and marginal costs.[27]

_ Interstate/Intrastate Differences and Differences Between Carriers. There is often a substantial difference between incumbent local exchange carriers' interstate and intrastate rates for identical services using identical facilities in exactly the same manner (e.g., the difference between interstate and intrastate access charges) and substantial differences in rates among incumbent local exchange carriers for services that use substantially similar facilities and technologies to serve the demands of substantially similar populations (e.g., the difference between BellSouth's access charges and GTE's access charges in Florida). These price differentials are simply not cost based or market driven, but can be variously characterized as monopoly rents, by-products of jurisdictional separations, or contribution.

Are all these mechanisms universal service subsidies? Certainly, they result in prices and charges that would not persist in a competitive environment and have no basis in economic costs, but with the exception of the programs targeted to end-users (Lifeline, Linkup, TRS) and rural telephone companies (Rural Telephone Loans) there is absolutely no evidence that these mechanisms are explicitly linked to the preservation of universal service. Instead, they amount to a giant corporate welfare program benefiting some of the world's largest most profitable corporations. Many of the subsidy programs described above are not explicit nor are they targeted to supporting universal service, but rather, focus on preserving incumbent local exchange carrier revenues. In establishing an explicit universal service support mechanism, the Commission and the Joint-Board has an opportunity to greatly clarify the structure of universal service support. It should establish an explicit universal service support mechanism and eliminate the complex structure of subsidies described above.

Universal service support, if required, should be administered by an independent entity. Experience with the universal service "fuzzball" clearly demonstrates that universal service support mechanisms that are administered by the beneficiaries (e.g., the USF, LTS and the host of internal cross-subsidies described above and maintained by incumbents) cannot be explicitly known, completly objective or competitively neutral. If the Commission and the Joint-

Board establish a universal service funding mechanism, it should be administered by an independent entity that has no competitive interest in who receives or who provides universal service support.

D. Universal Service Support Must be Targeted, Competitively Neutral, and Portable Among Competitors

As the Commission and Joint-Board develop universal service policies they should refrain from implementing programs designed to generate broad untargeted subsidies. Universal service support, if any, should be narrowly targeted to the end-users who, without extraordinary assistance, could not afford service in a competitive market. Not everyone and every area in the United States needs to receive subsidized telephone service; universal service support should be the exception and not the rule.

As described in the Staff's Universal Service Survey, the gains in telephone subscribership have leveled off in the last decade and the majority of persons without telephone service once were subscribers who dropped off the network because of an inability to pay toll charges.[28] Thus, arguably the "fuzzball" of untargeted subsidies no longer contributes to the advancement of universal service.

Universal service support should be targeted to customers, and not to telephone companies. In developing universal service policies, it may be appropriate to target low income customers who, without assistance, would be unable to afford telephone service. Lifeline, Link Up and TRS programs are obvious examples of support targeted to end-users. It may also be appropriate to target customers who live in unusually high cost service areas, where, without assistance, telephone service would be unaffordable. Rather than provide universal service support to telephone companies to support operations, costs and facilities that may have no relationship with universal service, universal service support should follow customers who can effectively direct it to whomever provides supported service to them.

As the Commission Staff described in its Universal Service Survey, since households who drop off the network do so for an inability to control toll charges, targeted support need not take the form of financial assistance for local telephone service. Rather, as described in the Commission Staff's Universal Service Survey, the Commission and the Joint-Board should consider targeted assistance to include options such as limitations on disconnection of local service for failure of low-income households to pay toll services, low cost toll blocking services, self-certification by households of their eligibility for Lifeline and Link Up assistance, and "quick dial tone" access to 911 emergency services.[29]

Throughout the Notice, the Commission solicited comments on the degree to which universal service support should be competitively neutral.[30] Because of the overarching pro-competition goals of the Telecommunications Act and specific language in the Act, universal service support should be competitively neutral in two respects:

_ Firms that receive universal service support should not be placed at a competitive advantage over competitors who do not receive universal service support.

_ Firms that provide universal service support, either in-kind or monetary payments, should not be placed at a competitive disadvantage by virtue of providing such support.

Congress' intent that receipt of universal service support be competitively neutral is evident in the language of Section 254(k) of the Telecommunications Act, which expressly prohibits subsidies from non-competitive services to competitive services.

A telecommunications carrier may not use the services that are not competitive to subsidize services that are subject to competition. The Commission, with respect to interstate services, and the States, with respect to intrastate services, shall establish necessary guidelines to ensure that services included in the definition of universal service shall bear no more than a reasonable share of the joint and common costs of facilities used to provide those services.[31]

Similarly, Section 254(e) requires that recipients of universal service support use it only for the services for which the support is intended,[32] and Section 254(h)(2) requires that "the Commission shall establish competitively neutral rules" for the provision of advanced telecommunication services to schools and libraries.[33] Congress' intent that the provision of universal service support be competitively neutral is evidenced by the principles of universal service which require that "all providers of telecommunications services" should contribute to universal service,[34] and the requirements of Section 254(d) that "[e]very telecommunications provider that provides interstate telecommunications services shall contribute, on an equitable and nondiscriminatory basis, to the specific, predictable, and sufficient mechanisms established by the Commission to preserve and advance universal service."[35]

The best way to ensure that universal service support received is competitively neutral is to provide such support to low income or high-cost customers as a credit that can be applied to whatever telecommunications service provider the customer chooses. Said differently, a system of customer credits should be entirely portable among service providers and whomever provides service to a supported low-income or high-cost customer would be entitled to receive universal service support. Both Lifeline and Link Up are programs that could be easily portable among competitors, but there is no portable support among high-cost customers.

To ensure that universal service support is competitively neutral among those who contribute to universal service funding, the Commission and Joint-Board should develop funding mechanisms that spread the burden of universal service funding among all telecommunications service providers. The best way to equitably spread the burden is to apportion responsibility for funding based on each firm's respective revenues net of payments to intermediaries. Thus, a long distance carrier's share of the universal service funding would be based on its revenues less access payments to local exchange carriers. A local telephone company's share of universal service funding would be based on its revenues less payments to other local exchange carriers for interconnection, compensation and unbundled network elements.

II. SUPPORT FOR RURAL, INSULAR, AND HIGH-COST AREAS AND LOW-INCOME CONSUMERS

A. Only Basic Local Telephone Service in High-Cost Areas or Provided to Low Income Customers Should be Included Among Potentially Subsidized Services

In its Notice, the Commission seeks comments on the scope of services that should be included in the basket of services considered part of universal service and thus, eligible for a universal service subsidy.[36] Only basic local telephone services should be considered a component of universal service and eligible for universal service subsidies. The core services listed by the Commission in its Notice are a reasonable collection of services that should be considered part of universal service.[37] Any authorized carrier that provides this core collection of services, either using a switching platform it owns (or substantially controls) and employing number resources assigned to it as a local exchange carrier should be considered an eligible carrier under the provisions of Section 214(e). The Telecommunications Act is intended to be pro-competitive, deregulatory in nature. Since competitive markets are not characterized by subsidized offerings, extending subsidies to more than just a basic collection of services would fly in the face of this pro-competitive legislative intent.

A market cannot be considered competitive if everyone and every area in that market receives a subsidy. Thus, it would be contrary to the pro-competitive deregulatory intent of the Telecommunications Act if universal service subsidies were developed for every consumer in every market. Rather, basic local telephone services should be subsidized only for low income consumers and consumers in high-cost service areas where, without extraordinary assistance, service would be unaffordable. As the Commission Staff noted in its Universal Service Survey, existing programs that target assistance to low income households are widely deployed in the United States. Thirty-six states participate in the Lifeline program (which waives all or a portion of the $3.50 subscriber line charge) and Link Up (which pays half of the first $60 of connection charges) is available in all but two states.[38] The costs of such targeted assistance are modest -- in 1994, 4.4 million households took advantage of Lifeline assistance at a total cost of $123 million and 840,000 households received $19 million of Link Up assistance.

B. Determining the Size of the Universal Service Fund

The Commission seeks comments on how to determine the size of any universal service subsidies, and how to assess standards such as "affordable" and "reasonably comparable" for rural, insular and low income customers.[39] Determining the size of a universal service fund requires that the Commission and Joint-Board identify the areas and individuals that ought to be subsidized and fix the amount of subsidy to be provided to such areas and individuals.

The proxy cost model described by the Commission in its Notice[40] provides a carrier-independent mechanism for identifying the total costs of providing local residential service at a census block level.[41] Those costs can be used to identify the nation's high-cost service areas. Because they are developed using census block data, the results of the proxy cost model can also be matched to household incomes, so that services provided to consumers in wealthy areas like Jackson Hole, Wyoming or Bar Harbor, Maine are not unnecessarily subsidized. Obviously, the Commission and the Joint-Board will have to set cost and income thresholds, which is fundamentally a subjective judgment. MFS suggests as a starting point that the Commission classify census blocks as high cost areas when such areas have per line costs greater than 130% of the national average, and restrict subsidies to census blocks where the average household income is greater than 130% of the national average.

For high-cost census blocks that are not also high-income areas, the universal service subsidy can be simply the difference between the per line proxy costs and 130% of the national per line average proxy costs. Any eligible carrier under the provisions of Section 214(e) that provides service to such high-cost census blocks would be eligible to receive the subsidy on a per line basis. Such a mechanism would be simple to administer and portable among competitors since the subsidies would track whomever a customer selected to be her service provider. It would also be explicit, predictable, sufficient, targeted, and replace the existing untargeted high-cost support mechanisms, including USF, DEM weighting and LTS. Because support would be based on census blocks, which are only about 400 households, as a practical matter, carriers would serve everyone in the census block rather than target only the most lucrative customers.

High-cost universal service support should be capped at the existing high-cost support levels. In 1996 USF is estimated to generate $734.6 million, DEM weighting is estimated to generate about $311 million.[42] There is no reason to expect that support for high-cost areas will exceed this level in a competitive market since that level of support has been adequate to advance universal service in a monopoly environment. Thus, a proxy cost model should be used to determine the size of the high-cost support fund subject to the aggregate cap. If the proxy cost model is larger than the cap, then it should be used to apportion high-cost support funds among firms that serve high-cost areas.

Such a universal service funding mechanism would be in addition to existing programs aimed to providing subsidized service to low income customers, namely Lifeline and Link Up. There is no compelling reason to modify these existing programs as they already provide a mechanism that targets support to low income individuals.

Regulating the level of local service rates should continue to be the responsibility of state regulators who have historically ensured that local rates are "affordable." Because "affordability" can vary from location to location, the Commission and the Joint-Board should not become mired in trying to determine a national standard for "affordable" local service prices.[43] If universal service support is based solely on the difference between proxy costs and 130% of the national average costs, there is no need to wrestle with what constitutes "affordable" local service rates.

III. SCHOOLS, LIBRARIES, AND HEALTH CARE PROVIDERS

The Telecommunications Act requires that the Commission develop distinct funding mechanisms for schools, libraries and rural health care providers. Under the Telecommunications Act, schools and libraries are to be provided access to the bundle of services included in the universal service definition at "rates less than the amounts charged for similar services to other parties."[44] The discount shall be determined by the Commission for interstate services and States for intrastate services that is necessary to "ensure affordable access to and use of such services" by schools and libraries. In addition, the Commission is directed to establish "competitively neutral rules" to enhance access to advanced telecommunications services for all public and non-profit elementary and secondary school classrooms, health care providers and libraries.[45]

It is important to note that the development of a discount for schools and libraries extends only to the package of services included in universal service. Thus, given the limited package of services that the Commission proposes to include in universal service, and given the prices of local telephone service, it is not clear that schools and libraries do not already have affordable access to and use of universal service functionalities.

Certainly, there are many schools and libraries that wish to enhance their ability to use telecommunications technologies. For example, Internet connections in every classroom might be desireable. However, discounting the price of dial-up service included in universal service will not likely make much impact on schools' use of the Internet as the price of computer hardware and software are large relative to phone costs. A $25 local line and a $20 monthly subscription fee to an Internet service provider are swamped by the $3,000 that might be required to buy a computer with a modem and appropriate software to access the Internet. Realistically, discounting the $25 local line will likely have no impact on whether schools can afford to access and use the Internet.

The Commission can promote access to advanced telecommunications service simply by promoting local telephone competition. As competition develops, new firms will want to serve schools, libraries and health care providers. For example, in the competitive personal computer market, manufacturers like Zenith and Apple have historically provided discounts for computers purchased by students and faculty. Such discount programs were often premised on the notion that students and faculty would continue to purchase Zenith and Apple products after graduation. Similar incentives may encourage competitive local service providers to provide service at a discount in order to give future consumers a "taste" of their services.

IV. OTHER UNIVERSAL SERVICE SUPPORT MECHANISMS

The Commission seeks comment on whether to change the existing mechanisms for recovering non-traffic sensitive ("NTS") loop costs through a combination of usage sensitive CCL charges and flat-rate SLCs paid by end-users.[46] Generally speaking, because long distance traffic grows faster than local loops, usage sensitive CCL charges generate revenues faster than loop costs resulting in a windfall for incumbent local exchance carriers. The mismatch between CCL, SLC and NTS costs is well documented[47] and the structure of access charges, such as the recovery of NTS costs, is in need of reform. Clearly, preserving the windfall generated by the mismatch of revenues and costs is not essential to preserving universal service. Moreover, CCL revenues are not targeted in any fashion at promoting, preserving or maintaining universal service by underwriting service to low income households or high-cost areas. The CCL revenues are simply general revenues that incumbent local exchange carriers can use in any way they wish. Thus, preserving the CCL is not essential to preserving universal service.

Reform proposals include: (1) recovering NTS costs entirely from end-users; (2) recovering the CCL portion of NTS costs from long distance carriers in the form of flat-rate charges rather than per minute charges; and, (3) capping the CCL portion of NTS costs and allowing it to grow only as loops are added and annually reducing the per minute CCL charge. Recovering NTS costs from end-users is the most direct, economically sensible solution since end-users' subscription to telephone service causes those costs to be incurred and end-user customers ultimately pay those costs either directly in the form of local service charges or indirectly as inflated long distance rates. Historically, however, the transition to explicit end-user paid NTS costs has been politically difficult. Plans that propose to recover the CCL portion of NTS costs from long distance carriers in the form of flat rate charges are often schemes to guarantee incumbent carriers' CCL revenues, and properly, should be rejected. The best option is to cap CCL revenues, phase out the CCL and, as necessary, increase the SLC. If support is based on loop costs as MFS suggests, in order to avoid double recovery by carriers with loop costs greater than 130% of the national average, it is essential that the CCL be eliminated and NTS cost recovery transferred to end-users.

V. ADMINISTRATION OF SUPPORT MECHANISMS

The Commission seeks comments on who should contribute to universal service funding and who should administer such a fund.[48] The Telecommunications Act requires that "[e]very telecommunications carrier that provides interstate telecommunications services shall contribute, on an equitable and nondiscriminatory basis" and allows the Commission to exempt a carrier or class of carriers if the carrier's "contribution to the preservation and advancement of universal service would be de minimis."[49]

For administrative ease, the Commission should exempt carriers with less than a 1% market share as it presently exempts carriers with less than a _% market share (i.e., carriers with less than about 72,000 access lines) from contributing to the USF.[50] Because multiple carriers with different service configurations are involved, market share should be calculated based on revenues net of payments to intermediaries like the mechanism the Commission recently established in its Regulatory Fees Order.[51] Thus, a local exchange carrier's market share would be based on its revenues less compensation payments, interconnection payments, resale payments and payments for unbundled network elements that it makes to other telecommunications providers. A long distance carrier's market share would be based on its revenues less access payments and payments for long distance services it buys and resells.

Carriers that contribute to the universal service fund should include carriers that are common carriers since the definition of "telecommunications services" in the Telecommunications Act is "the offering of telecommunications for a fee directly to the public."[52] Providers like private network providers or Shared Tenant Services ("STS") providers do not generally offer their services to the public and should be excluded from requirements to provide universal service funding. Also, if the Commission excludes carriers with less than a 1% market share from providing universal service support, such private network providers will likely be excluded anyway. Likewise, carriers that provide a mix of public and private telecommunications services should exclude the private service revenues and costs from their revenues used to develop market shares.

Administration of the universal service fund -- collection and distribution of funds -- should be performed by an independent third party with no competitive interest in who pays or who receives universal service funds. NECA, USTA and Bellcore both are all entities comprised of incumbent local exchange carriers and would be unsuitable as fund administrators. State commissions do not likely have the resources or the jurisdiction to address administration of a universal service fund. Unless the funds are targeted to specific states, state commissions may not have the jurisdiction to administer collections and distribution of funds (e.g., the South Dakota commission may not be able to require Metromedia to contribute to a fund that supports services in South Dakota unless Metromedia operates in South Dakota). A non-governmental fund administrator whose expenses are paid for from the fund should be employed to administer universal service support.

VI. CONCLUSIONS

The Telecommunications Act is designed to promote the development of competition in all market segments of the telecommunications industry. Recognizing this objective, as the Commission and the Joint-Board develop universal service policies, they should design policies that recognize the role of competition in promoting universal service and designing policies that are competitively neutral.

Respectfully submitted,

Andrew D. Lipman
Mark Sievers

SWIDLER & BERLIN, CHARTERED
3000 K Street, N.W., Suite 300
Washington, D.C. 20007
(202) 424-7500

Attorneys for
MFS COMMUNICATIONS
COMPANY, INC.

Dated: April 12, 1996

ATTACHMENT 1
FROM MFS'S FILING IN RM8388

LOCAL TELEPHONE COMPETITION
AND THE "$20 BILLION SUBSIDY":

WHAT IT REALLY MEANS AND
WHAT TO DO ABOUT IT

Local telephone companies have long claimed that the introduction of competition into their protected monopoly markets would endanger "subsidies" that keep basic telephone service affordable for all Americans. Some studies sponsored by the telephone industry estimate the "subsidy" at $20 billion per year.

Although this figure strains credibility and is not supported by the limited evidence, rather than argue about the existence or amount of subsidies, MFS Communications Company[53] believes that policymakers should concentrate on the constructive task of how to assure that affordable basic service remains available in a competitive market. This White Paper outlines a program to assure that basic service remains universally available at affordable rates, and that the cost of this program is borne equitably and in a competitively-neutral manner by all participants in the telecommunications market.

How is Telephone Service "Subsidized" Today?

Unlike some other industries, most telephone companies do not receive any direct subsidy from the U.S. Treasury. Rather, according to the local exchange companies ("LECs"), a variety of explicit and implicit subsidies are inherently incorporated into the rates paid by telephone users and subsequently collected and reallocated by the LECs themselves. Total LEC revenues cover the costs of profitable services, contribute to LEC overhead (regardless of their level of efficiency) and shareholder return, and reportedly also cover the costs of certain unprofitable or subsidized services.

First, three explicit subsidy programs are administered by the National Exchange Carrier Association (NECA) under FCC rules.[54] Two of these programs, the Universal Service Fund and the Lifeline Connection Fund, are funded by assessments on long-distance carriers. The Universal Service Fund provides direct subsidy payments to "high-cost" local exchange companies under a complex formula adopted by the FCC. The Lifeline Connection Fund compensates telephone companies for some of the revenue lost when they reduce or waive one-time connection charges for eligible low-income consumers. According to the FCC, these two programs collect and distribute about $800 million per year. The third program is the Common Line Pool, under which NECA receives "support" payments from large telephone companies and uses the funds to subsidize the line costs of the smaller companies that participate in the pool. The LECs that pay into the pool recover these amounts through their charges to long-distance carriers for network access. The amount of subsidy contained in this system is harder to measure because some of the pool represents companies' actual revenues and costs rather than a subsidy.[55] Many states have their own independent subsidy programs, as well.

Second, and more significantly, the telephone companies argue that basic local telephone service is implicitly subsidized through higher prices for long-distance services (including both the short-haul toll services offered by the telephone companies themselves, and their charges to long-distance carriers for network access). This artificial pricing, they claim, keeps basic local rates lower for everyone. Therefore, customers who generate a lot of switched long-distance calls "subsidize" those who make few or none. (The FCC has concluded that special access services used by large business customers with private lines are not priced above cost and therefore do not contribute any subsidy.) Furthermore, the local telephone companies argue that the introduction of local competition would cause them to lose revenue as long-distance calls are originated and terminated over competing networks, forcing them to raise basic local rates for their remaining subscribers.

What's Wrong with the Current System?

Today's "universal service" system is a giant "fuzzball," perpetuated by the LECs, which hides costs, distorts competition and otherwise causes policy concerns. First, the complexity and obscurity of the "hidden" or "implicit subsidies" allow the local telephone companies to use them as a shield against competition. Telephone companies reflexively argue that any additional competition will result in a dire threat to universal service--as, in fact, the Bell System argued in the 1970's when faced with nascent competition in terminal equipment marketing and long distance service. It didn't happen then and it needn't happen now.

Second, because most of the alleged "subsidies" are hidden in long-distance charges and supposedly are reflected in reduced local charges, it is impossible for policymakers to verify how much of an actual subsidy exists or who really benefits from it. The telephone companies' $20 billion estimate is based on LEC cost studies, many of them secret, none of them readily verifiable by regulators, ratepayers or competitors. Some or all of the alleged "subsidy" could actually result from prices inflated to compensate for LEC inefficiency or excessive returns to LEC stockholders. Subsidies must be made explicit so regulators can monitor them and ensure that they are appropriately assessed and distributed.

Third, long-distance service is not used solely by the wealthy and local service is not used solely by the needy, so inflating the cost of one to subsidize the other will have undesirable consequences and distort competitive markets. (In fact, certain studies indicate that lower income users have a disproportionately high long distance usage.) In an increasingly mobile society, working Americans shouldn't have to pay inflated rates for long-distance calls to friends and relatives in order to subsidize cheap telephone lines for well-heeled subscribers. Subsidies should be targeted to those who need them.

Fourth, to the extent explicit subsidies do exist today, they are largely targeted to "high-cost" local telephone companies. This gives the recipients a perverse incentive to keep their costs high and rewards inefficiency. Moreover, it leads to an extraordinary situation of low- and middle-income urban users subsidizing wealthier suburban, exurban and rural users. Even prosperous areas like Jackson Hole, Wyoming; Middleburg, Virginia; or Bar Harbor, Maine might qualify for subsidies. Subsidies should be targeted to end users, not to telephone companies.

How Can Universal Telephone Service Be Assured In a Competitive Environment?

Competition in local telephone service need not result in increases in basic local rates, especially for those individuals who are targeted to receive subsidized service--but it does require a new mechanism so that the cost of subsidies (whatever the dollar amount may be) is borne equitably by all market participants. As with other facets of the telecommunications industry, MFS believes that local competition will ultimately lead to an increasing array of differentiated services and lower rates for all Americans.

MFS supports a "play or pay" universal service program, to which all providers of telecommunications service would be required to contribute on a competitively-neutral basis either by providing subsidized services to eligible end-users, by making cash payments into a subsidy fund, or both. This proposal is premised on the elimination of entry barriers for all telecommunications services--all services, including basic local dialtone, would be opened to full competition

Universal service would be maintained in a fully competitive market based on the following principles:[56]

* All existing FCC- and similar State-mandated subsidy programs should be replaced by an independent Universal Service Assurance Fund administered by a neutral third party administrator [perhaps after an appropriate transition period]. (This should not be confused with the existing, and much more limited, "Universal Service Fund" administered by NECA under FCC supervision.)

* The objective of the Universal Service Assurance Fund should be to provide credits to those individual customers who would not otherwise be able to afford basic local telephone service. These customers include the following categories:

1. Low income users;

2. Customers in "high cost" (mostly rural) areas; and

3. Special needs groups (e.g., individuals with disabilities requiring special equipment to obtain access to basic service).

* Subsidies for "high cost" areas should be targeted based on objective criteria such as population density, geography, income statistics and other subscriber characteristics; not on actual telephone company costs (thus eliminating any incentive for LECs to inflate costs in order to keep receiving subsidies).

* Eligible customers should receive a credit on their monthly bill to reduce the price of basic service to an affordable level (based on historical local service rates indexed for inflation), regardless of which carrier they obtain service from.

* All telecommunications service providers (such as LECs, CAPs, IXCs, Cellular, PCS) should be assigned a Universal Service Assurance obligation based on consistent and competitively-neutral criteria (such as a percentage of revenues, a fixed amount per access line, or some similar basis). The obligation could be satisfied either by cash payments to the Fund, by extending credits to eligible consumers, or a combination of both.

* The independent Fund administrator should monitor the allowance of credits and the determination of eligibility; determine the industry-wide assessment required to fund the program; settle accounts periodically; collect payments from those service providers who do not satisfy their full obligation through credits to end users; and distribute payments to those carriers who grant credits in excess of their allotted obligation.

To further assure universal service, the incumbent monopoly LECs should continue for the foreseeable future (until alternative services are widely available) to be required to serve all customers within their existing service areas (although they would receive a Universal Service Assurance Fund credit for serving eligible consumers at subsidized rates). Since rates would be allowed to move to cost-based levels (before Universal Service Assurance credits), however, LECs would be fully compensated for serving all customers and there would be an economic incentive for CAPs and other carriers to compete to serve these customers, even in "high-cost" areas, if they can do so more efficiently.

CERTIFICATE OF SERVICE

I hereby certify that on this 12th day of April 1996, copies of the foregoing COMMENTS OF MFS COMMUNICATIONS COMPANY, INC. in Docket 96-95, were served via Messenger** or First-Class Mail, U.S. postage prepaid, to the parties on the attached service list.

[Service list deleted from online version.]

Sonja L. Sykes-Minor

[2]Telecommunications Act of 1996, Pub. L. 104-104, 110 Stat. 56 (1996).

[3]47 U.S.C. [[section]]254(a)(1).

[4]In fact, countries with very low telephone penetration, like Mexico, Brazil, and other Latin American countries, are opening their telecommunications markets to competition. Such actions would be irrational if competition actually threatened universal service. One explanation is that competition stimulates investment in telecommunications infrastructure, attracts new entrants and stimulates demand for telecommunications services.

[5]Common Carrier Bureau, Preparing for Addressing Universal Service Issues: A Review of Current Interstate Support Mechanisms, pg. 26 (Feb. 23, 1996) ("Universal Service Survey") [emphasis added, footnotes omitted].

[6]When proposing to offer competitive local exchange services, even incumbent local telephone companies agree that competition stimulates universal service. For example, in testimony filed with the Maryland Public Service Commission, Michael Gilliam, the President of SBC Media Ventures, a wholly owned subsidiary of SBC, stated flatly that "SBC-MV believes that competition can enhance universal service. Competition generally reduces prices and makes telephone service more affordable." In the Matter of the Investigation by the Commission on its Own Motion into Legal and Policy Matters Relevant to the Regulation of Firms, Including Current Telecommunications Providers and Cable Television Firms, which may Provide Local Exchange and Exchange Access Services in Maryland in the Future, Case No. 8587, Direct Testimony of Michael Gilliam on Behalf of SBC Media Ventures, Inc. pg. 11 (June 10, 1994).

[7]Industry Analysis Division, Common Carrier Bureau, Summary of State Telephone Rate Cases (March 1996). The reported figure is total revenue reductions ($5.3 billion) minus total revenue increases ($202 million) ordered by state commissions.

[8]NYNEX expects to double revenues by 2003-2005, THE MORNING REPORT (March 28, 1996) MFS newsclipping service drawn from Reuters News Services.

[9]Universal Service Survey at pp. 28-29.

[10]D. Kline, Align and Conquer, 3.02 WIRED 100, 164 (Feb. 1995).

[11]Telecommunications Act, Conference Report, p. 1.

[12]In the Matter of Amendment of Part 36 of the Commission's Rule and Establishment of a Joint-Board, CC Docket 80-286, Notice of Inquiry, 9 FCC Rcd 7404 at [[paragraph]] 12 (released Aug. 30, 1994) and Notice of Proposed Rulemaking and Notice of Inquiry, 10 FCC Rcd 12309 at [[paragraph]][[paragraph]] 55-63 (released July 13, 1995).

[13]Universal Service Survey at pp. 29-30.

[14]47 U.S.C. [[section]]254(e). "Any such support should be explicit and sufficient to achieve the purposes of this section."

[15]47 U.S.C. [[section]]254(d).

[16]Id.

[17]Joint Explanatory Statement of the Commitee of Conference, p. 131.

[18]A review of telecommunications subsidy studies is in C. Weinhaus, et al., Apples and Oranges: Differences between Various Subsidy Studies, Telecommunications Industry Analysis Project (July 19, 1995).

[19]Notice at [[paragraph]][[paragraph]] 14, 40-45.

[20]Notice at [[paragraph]][[paragraph]] 61-65.

[21]Notice at [[paragraph]][[paragraph]] 112-114.

[22]Notice at [[paragraph]] 115.

[23]Universal Service Survey at pp. 78-89.

[24]Universal Service Survey at pp. 45-49.

[25]Universal Service Survey at pp. 100-106. An estimate of the aggregate subsidies associated with geographic averaging is presented in C. Weinhaus, What is the Price of Universal Service? Impact of Deaveraging Nationwide Urban/Rural Rates, Telecommunications Industry Analysis Project (July 26, 1993).

[26]Universal Service Survey at pp. 111-124.

[27]C. Monson & J. Rohlfs, The $20 Billion Impact of Local Competition in Telecommunications, Strategic Policy Research (July 16, 1993).

[28]Universal Service Survey at pg. 17. Also see M. Mueller & J. Reina Schement, Rutgers University Project on Information Policy, Universal Service from the Bottom Up: A Profile of Telecommunications Access in Camden, New Jersey (1995).

[29]Universal Service Survey at pp. 19-21. Also see NTIA Comments in In the Matter of Amendment of the Commission's Rules and Regulations to Increase Subscribership

[30]Notice at [[paragraph]][[paragraph]] 8, 17.

[31]47 U.S.C. [[section]]254(k). [emphasis added]

[32]47 U.S.C. [[section]]254(e). "A carrier that receives such support shall use that support only for the provision, maintenance, and upgrading of facilities and services for which the support is intended."

[33]47 U.S.C. [[section]]254(h)(2).

[34]47 U.S.C. [[section]]254(b)(4).

[35]47 U.S.C. [[section]]254(d).

[36]Notice at [[paragraph]][[paragraph]] 16-23.

[37]Notice at [[paragraph]] 16. The core services include: (1) voice grade access to the public switched network with the ability to place and receive calls; (2) touch-tone service; (3) single party service; (4) access to emergency services (911); and, (5) access to operator services.

[38]Universal Service Survey at pp. 34-35.

[39]Notice at [[paragraph]][[paragraph]] 25-39.

[40]Notice at [[paragraph]][[paragraph]] 31-34.

[41]The proxy cost model does not provide an estimate of the costs to provide the bundle of core services the Commission proposes to include in universal service. Thus, if it is used, the proxy cost model would have to be modified to include such costs.

[42]Universal Service Survey at pp. 53, 66 (1995 estimate for DEM weighting).

[43]Notice at [[paragraph]][[paragraph]] 25-26.

[44]47 U.S.C. [[section]]254(h)(1)(B).

[45]47 U.S.C. [[section]]254(h)(2).

[46]Notice at [[paragraph]][[paragraph]] 112-115.

[47]Universal Service Survey at pp. 90-99.

[48]Notice at [[paragraph]][[paragraph]] 118-131.

[49]47 U.S.C. [[section]]254(d).

[50]47 C.F.R. [[section]] 69.116(a).

[51]Notice at [[paragraph]] 123 citing Assessment and Collection of Regulatory Fees for Fiscal Year 1995, Price Cap Treatment of Regulatory Fees Imposed by Section 9 of the Act, Report and Order, 10 FCC Rcd 13512 (1995).

[52]47 U.S.C. [[section]]153(51) [emphasis added].

[53]MFS Communications Company, Inc. (MFS) is the largest provider of local competitive access telecommunications services in the United States. As an integrated telecommunications company, MFS provides a wide range of high quality voice, data and other enhanced services and systems designed to meet the requirements of communications-intensive business and government end users. Through subsidiaries, MFS owns and operates local fiber optic communications networks in 14 major metropolitan business centers throughout the United States. As of June 30, 1993, the company's fiber optic networks consisted of 1,030 route miles and 50,049 fiber miles.

[54] There are also other mechanisms built into the FCC's cost allocation rules that permit small telephone companies to recover a greater share of their costs through long-distance access charges than do the large companies.

[55] Long-distance access charges also recover some of the costs of reducing monthly local service charges for low-income consumers.