I. Introduction

Today we conclude the important cost phase of a two year investigation to examine and establish updated universal service principles and policies for basic telecommunications services in the Commonwealth. The Opinion and Order we adopt today paves the way for effective competition in all areas of Pennsylvania, encourages infrastructure modernization in accordance with the directives of Chapter 30 of Title 66 of the Pennsylvania Consolidated Statutes, and ensures that all Pennsylvanians will have access to affordable and basic telephone service in the new competitive marketplace that is emerging.

II. Background

A. Procedural

This proceeding was commenced by the Commission on June 15, 1994, through the issuance of an Order initiating a formal investigation to examine and establish updated universal service principles and policies for basic telecommunications in the Commonwealth.(1) The Order solicited comment from interested parties on a myriad of issues related to the concept of "universal service", with special emphasis on how universal telephone service should be defined in Pennsylvania.

On April 10, 1995, after careful review and consideration of the comments received, the Commission entered an Order which bifurcated the investigation into three separate proceedings. In the first proceeding, the Commission initiated an ongoing rulemaking docket at L-00950102 to establish parameters for evaluation and review of the initial definition of "universal service" on an ongoing basis.(2)

The second proceeding commenced by the Commission's June 15, 1994 Order was the initiation of a proposed rulemaking at L-00950105 for the purpose of creating a universal service funding mechanism.(3) After carefully considering the comments of all parties, the Commission entered a Final-Form Rulemaking adopting a universal service funding mechanism on June 21, 1996. A Petition for Reconsideration was filed by GTE North Incorporated on July 10, 1996, which was subsequently denied by the Commission.

In the third and final universal service related proceeding, which we address today, the Commission set forth three principle issues for resolution:

(1) application of cost study methodology, the submission of universal cost studies into the record and review of the results of these studies, including evaluation of relevant subsidies, assuming present LEC price levels, pertaining to universal service. Analysis of relevant subsidies was to be evaluated both between cost study areas and between basic universal service and other services
(2) identification of a basic universal service rate and evaluation of hypothetical subsidies between cost study results and the basic universal service rate;
(3) identification of rate rebalancing plans by LECs, evaluation of the effect on universal service caused if rebalancing were permitted and identification of hypothetical subsidies which result or remain if rebalancing is presumed relative to both the cost study results and the basic universal service rate. Order, September 5, 1995 at 20-25.

By Order entered October 4, 1995, in the matter of Application of MFS Intelenet of Pa., Inc., Docket No. A-310203F.0002, the Commission included access pricing as an additional issue to be addressed in this case. By Secretarial Letter dated October 6, 1995, the Commission asked parties to also address appropriate reciprocal compensation rates, since agreement could not be reached between the parties on this important issue.

During this phase of the proceeding, parties were asked to respond to questions initially promulgated by the Commission, participate in a public forum on July 6, 1995, and file position papers on cost study methodology issues. The Commission subsequently referred the cost issues to the Office of Administrative Law Judge for development of an evidentiary record within 200 days from entry of the PUC's Order. Id. at Ordering Para. 2. A prehearing conference was held on September 27, 1995, before Administrative Law Judge Louis G. Cocheres. Testimony on the various cost models was submitted by most parties on December 8, 1995, and prepared testimony dealing with the remaining issues was served on January 4, 1996. Evidentiary hearings were held from March 4, 1996 through March 13, 1996. Thirty-four witnesses were presented for cross-examination and the record closed on March 25, 1996. Main briefs were due on April 12, 1996 and reply briefs were due on April 26, 1996. By Commission Order entered April 4, 1996, the close of the official record was extended to the date of filing of Reply Briefs on April 26, 1996. Parties were given an extension to file Reply Briefs until April 30, 1996.

The following active parties of record participated in the evidentiary hearing and other phases of this proceeding: Office of Consumer Advocate ("OCA"), Office of Small Business Advocate ("OSBA"), Pennsylvania Telephone Association ("PTA", Bell Atlantic-PA, Inc., ("Bell"), GTE North ("GTEN"), Sprint/United Telephone ("Sprint/United"), ALLTEL Pennsylvania, Inc., North Pittsburgh Telephone Company, Armstrong Telephone Company, and Lackawaxen Telephone Company (collectively referred to as "ALLTEL"), Sprint Communications Company, ("Sprint"), Pennsylvania Cable and Telecommunications Association ("PCTA"), Eastern Telelogic Corporation ("ETC"), AT&T Communications of PA, Inc. ("AT&T"), Teleport Communications Group ("TCG"), and MCI Telecommunications, Inc. ("MCI").

On February 8, 1996, the Telecommunications Act of 1996 ("TA-96" or the "Federal Act") was signed into law. The Federal Act contains extensive universal service provisions and provides for the establishment of both federal and state funding mechanisms. Under the Federal Act, any state mechanism must be specific, predictable and sufficient to support the state's universal service objectives and the state mechanism cannot rely upon or burden the federal mechanism. The Joint Board Recommended Decision(4) on universal service was released on November 8, 1996. The Recommended Decision is approximately 450 pages long (excluding appendices) and establishes the proposed parameters for the Federal funding mechanism.

In this Opinion and Order, we once again endorse the use of a forward-looking cost study, based upon the proxy costs associated with a modern, technically efficient network to determine basic universal service costs. We establish the basic universal service rate, for purposes of determining the level of subsidy in high-cost areas of the state. We initiate a separate comprehensive generic proceeding on intrastate access charge reform. We summarize our findings in this Opinion and Order in much greater detail in Subpart I.(D) hereof. We have reviewed our findings herein in light of the Joint Board Recommended Decision, and find them to be consistent in all major respects.

B. Findings of the Commission In The Other Related Proceedings

1. Definition of Universal Service

We adopted the following initial definition of basic universal service ("BUS") in our April 10, 1995 Order:

Basic universal service - For purposes of this investigation, the term shall consist of the following service components:
a) single party, voice grade, incoming and outgoing access to the public switched network and usage within a local calling area:
b) touch tone capacity;
c) annual local directory;
d) access to operator services;
e) access to directory assistance;
f) access to telecommunications relay service and other services designed for persons with disabilities; and
g) access to emergency services.

This initial definition of BUS was supported by a broad cross-section of vested interests including LECs, IXCs, consumer interests, and others. Parties were instructed to use this initial definition of BUS for purposes of their BUS cost studies. We were also guided by this definition in making our determinations regarding BUS costs and in determining what the BUS rate should be.

We note that the definition adopted by this Commission is very similar to the definition which the Federal-State Joint Board has recommended be adopted for purposes of the Federal funding mechanism: voice grade access to the public switched network, with the ability to place and receive calls; touch-tone or dual tone multi-frequency signalling ("DTMF") or its functional equivalent; single-party service; access to emergency services; access to operator services; access to interexchange services; and access to directory assistance. In addition, the Joint Board recommended that states determine the amount of local usage to include in the universal service definition within their jurisdiction.(5) For purposes of determining the level of Federal universal service support, the Joint Board recommended that the FCC determine a level of local usage. Joint Board Recommended Decision at para. 49.

2. The Universal Service Funding Mechanism

On June 21, 1996, the Commission entered a Final-Form Rulemaking Order at Docket No. L- 00950105 which established the following parameters for a state universal service funding mechanism:

1. Contributions from all "telecommunications carriers" as provided under § 254(k) of the Federal Act. Whether a provider or class of providers is a telecommunications carrier will be determined based upon whether the provider or class of provider is considered a telecommunications carrier under federal law, as interpreted by the Federal Communications Commission. Since commercial mobile radio service ("CMRS") providers are "telecommunications carriers" under the Federal Act, they are required to contribute to the Pennsylvania state funding mechanism.
2. Each carrier's contribution will be computed based on its pro rata share of total statewide, intrastate operating revenues. In determining a contributing carrier's annual assessment rate or rates, the Commission will divide the contributing telecommunications provider's associated gross intrastate operating revenues by associated statewide gross intrastate telecommunications operating revenues.

3. The Commission will designate "eligible carriers" in each service area who will then qualify to receive state universal service funding.

4. Support from the mechanism will fund the difference between the cost of providing basic universal service in a given basic service area and the basic universal service rate.
5. Each subscriber in a high cost of service area will be credited on a monthly basis from eligible telecommunications providers equal to the amount that the cost of basic universal service established by the Commission for the subscriber's cost of service area exceeds the basic universal service rate.
6. All eligible carriers providing basic universal service to high cost areas would be eligible for support from the fund for each high cost subscriber they serve. Eligible carriers would receive reimbursement from the fund on a monthly basis.
7. The funding mechanism will be administered by an independent third party administrator subject to continuous oversight by the Commission. The administrator and fund auditor will be responsible for assessing telecommunications carriers, preparing and filing with the Commission an annual audit of the fund and making recommendations to the Commission pertaining to ongoing operation and modification of the fund.


C. The Telecommunications Act of 1996

Universal service is one of the primary objectives of the Federal Act. The Federal Act provides for separate Federal and State universal service support mechanisms. The Federal Act defines "universal service" for Federal funding purposes, as an evolving level of telecommunications services that the FCC shall establish periodically, taking into account advances in telecommunications and information technologies and services. The Joint Board and the FCC in establishing the definition of services supported by the Federal mechanism are to consider the extent to which the telecommunications services--

(A) are essential to education, public health, or public safety;
(B) have, through the operation of market choices by customers, been subscribed to by a substantial majority of residential customers;
(C) are being deployed in public telecommunications networks by telecommunications carriers; and
(D) are consistent with the public interest, convenience, and necessity.

Section 254(c)(3) provides that in addition to the services included in the definition of universal service, the FCC can designate additional services for schools, libraries, and health care providers. States must establish a discount applicable to intrastate services included within the definition of universal service for qualifying schools and libraries pursuant to § 254(h)(1)(B). Health care providers serving persons residing in rural areas are eligible to receive rates that are reasonably comparable to rates charged for similar services in urban areas in that State. See Section 254(h)(1)(A).

State authority in general is addressed at § 254(f) which provides:

(f) STATE AUTHORITY.--A State may adopt regulations not inconsistent with the Commission's rules to preserve and advance universal service. Every telecommunications carrier that provides intrastate telecommunications services shall contribute, on an equitable and nondiscriminatory basis, in a manner determined by the State to the preservation and advancement of universal service in that State. A State may adopt regulations to provide for additional definitions and standards to preserve and advance universal service within that State only to the extent that such regulations adopt additional specific, predictable, and sufficient mechanisms to support such definitions or standards that do not rely on or burden Federal universal service support mechanisms.

Section 254(i) of the Federal Act requires the Commission and States to ensure that universal service is available at rates that are just, reasonable, and affordable.

On March 8, 1996, the FCC commenced a rulemaking which established a Federal-State Joint Board to undertake a comprehensive review of universal service to comply with the requirements of the Federal Act. The stated purpose of the FCC's rulemaking was to: (1) define the services that will be supported by Federal universal support mechanism, (2) establish the support mechanisms, and, (3) recommend other necessary changes to existing FCC regulations which affect this issue.

On November 8, 1996, the Joint Board issued its recommendations to the FCC as required under Section 254 of the Telecommunications Act of 1996. We make reference to the relevant Joint Board proposals throughout the body of this Opinion and Order.

D. Summary of Commission Findings In this Investigation

A summary of the major findings in this phase of our Universal Service proceeding is as follows:

1. The record demonstrates that there is a need for the establishment of a universal service funding mechanism in Pennsylvania.
2. The cost studies indicate that the revenues for BUS exceed its costs; and therefore, that there is no subsidy in the aggregate. All of the models proposed in this proceeding also indicate, however, that the costs of providing service in rural areas far exceeds the rates charged in many instances.
3. While the record of this proceeding indicates that there may be a need for some rate rebalancing at some point in the future particularly with regard to access rates, there is insufficient evidence in this proceeding as to the amount of any rate rebalancing.
4. Bell's "play or pay" and/or rate rebalancing proposals are not effective substitutes for a state universal funding mechanism.
5. A universal service funding mechanism is necessary to: (1) maintain affordable rates in all areas of the Commonwealth in the future; (2) maintain and/or increase subscribership rates in all areas of the Commonwealth; (3) encourage competition in urban and rural areas and telecommunications markets in Pennsylvania; (4) achieve regulatory parity between incumbent and new providers; (5) ensure economic development in all areas of the State through the equal availability of basic and advanced services so that telecommunications infrastructure development in Pennsylvania does not disadvantage rural areas and result in a system of haves and have nots; (6) achieve more effective targeting of existing subsidies; (7) encourage carriers to meet the mandates of Chapter 30; and (8) carry out and comply with the requirements of the TA-96.
6. The use of auctions to determine the cost of universal service at this time is inappropriate. Consistent with the findings of the Joint Board, we find that the use of auctions for this purpose should not be foreclosed but should be the subject of further study by the Universal Service Task Force we establish today.
7. A multi-fund approach whereby a separate universal service fund is established for each incumbent local exchange carrier ("ILEC") service territory, or for Bell Atlantic's service territory with one or two funds for the remaining regions of Pennsylvania, would be difficult to administer, would be inconsistent with several provisions of the TA-96, and would result in the formation of barriers to entry in many high cost areas of the State. The interests of Pennsylvania carriers and consumers alike will be best served through the establishment of a single universal service funding mechanism.
8. A forward looking, proxy model which bases costs upon those of an efficient, modern up-to-date network is the most appropriate model for determining BUS costs in Pennsylvania.
9. The local loop is a joint or shared cost of providing BUS, and as such, should be allocated among the various services which share in its use. Subscriber line usage ("SLU") shall be used initially by the Commission to determine the percentage allocation of the local loop to BUS for larger Pennsylvania LECs. For smaller LECs, those with under 50,000 access lines and North Pittsburgh, 90% of the local loop will be allocated to BUS initially in recognition of the unique circumstances of many of the smaller LECs and their service territories.
10. The BCM 2 most closely meets our expectations at this time with regard to the appropriate costing model to determine BUS costs in Pennsylvania. However, because we do not want to preclude the use of a more accurate or viable option, the Universal Service Task Force which we establish today will be charged with continuing to examine and explore this model, other models, and improvements and updates to the various models to ensure that our funding mechanism utilizes the best possible and most accurate costing measures at all times. While we tentatively endorse the characteristics of the BCM 2 as a reasonable starting point, the Task Force's first mission will be to conduct a series of workshops to explore and examine the various improvements and enhancements that continue to be made to the various models. The Task Force shall also consider the methodology ultimately adopted by the FCC, and shall make recommendations to the Commission within 6 months on potential improvements that could be incorporated into the Pennsylvania model.
11. A universal service flat rate of $20.00 (including unlimited local usage) for the purposes of calculating universal service support is reasonable in Pennsylvania. By adopting this rate for the purpose of calculating universal service support, we do not in any way, however, represent that $20.00 (including unlimited local usage) is an acceptable local service rate in every area of the Commonwealth given the vastly different carrier cost and rate structures now in effect. The BUS rate's only function is as a benchmark for determining appropriate universal service funding levels in Pennsylvania.
12. Given the clear record evidence regarding the need for intrastate access charge reform, we initiate today a proceeding to examine intrastate access rate levels and pricing structures in a competitive marketplace. The results of the intrastate access charge reform proceeding shall be coordinated to the extent possible with implementation of the universal service funding mechanism and carriers shall take into account the results of both proceedings when submitting proposals to the Commission under Section IX of this Order.
13. A waiver process shall be available for small LECs if they would be adversely affected by the use of the proxy methodology adopted by the Commission today. This waiver process shall be available for an initial period of three years pending a determination as to its continuing need.
14. Reciprocal compensation rates shall be based upon TSLRIC plus a reasonable contribution to joint and common costs. This issue will be referred to MFS III and GTE II for the determination of the appropriate contribution amount that should be included in cost, consistent with the provisions of this Opinion and Order dealing with common cost allocation.
15. In non-rural service areas, carriers will be eligible for fund distributions on an exchange basis. Consistent with the Joint Board Recommended Decision, carriers will be eligible for fund distributions in rural service areas as long as they provide service throughout the incumbent rural company's study area. Joint Board Recommended Decision at para. 172.
16. The state funding mechanism shall be implemented over a four year transition period with 25% of the fund collected and distributed in year one, and an additional 25% of the fund collected and distributed in each of years 2, 3 and 4 with the fund becoming fully operational in year 4.
17. All LECs are required to file proposed Lifeline plans for low income customers with the Commission within 60 days from the entry date of this Opinion and Order. The Commission also encourages all companies to adopt Link-Up and Universal Telephone Assistance Programs ("UTAP") programs to assist low-income customers within their service territories.
18. A "Pennsylvania Universal Service Task Force" is established to address universal service issues on an ongoing basis and to make recommendations to the Commission as necessary and directed herein.
19. The Commission directs the Universal Service Task Force to address and make recommendations to it regarding the provisions in the Federal Act relating to Schools, Libraries and Health Care Institutions.