III. Need For Universal Service Fund in Pennsylvania

One of the Commission's primary objectives in this proceeding was to determine whether a universal service funding mechanism was even necessary in Pennsylvania. As discussed in detail below, we find that the establishment of a universal service funding mechanism is supported by the weight of the evidence in this proceeding. We also find that a funding mechanism will be critical in the future in order for the Commission to effectively carry out its responsibilities under Chapter 30 of the Public Utility Code. The record in this proceeding supports the establishment of a state funding mechanism on the following grounds:

A. To Maintain Affordable Rates In All Areas of the Commonwealth

Traditionally, residential rates have been maintained at affordable levels due to three factors. First, the jurisdictional separations process assigns 25% of the non-traffic sensitive ("NTS") costs of carriers to the interstate jurisdiction and also provides universal service support through higher or "weighted" allocations of switching costs in the case of smaller telephone companies. Second, other subsidies are provided through the Long-Term Support payments recovered in the Carrier Common Line Charges of non-NECA pool participants and the current Federal USF funding mechanism. Third, state regulators have designed rates in the past to ensure affordable residential rates. These support sources are now in a state of transition and it appears relatively clear that the support flowing from these sources in the future will not be as great as the transition to competition is made.

The Commission has responsibility under the Public Utility Code, 66 Pa. C.S. § 3001, et seq., to maintain universal service affordable rates in an increasingly competitive telecommunications environment. Additionally, a primary objective under § 254 of the Federal Act, is to make available "[q]uality services ... at just, reasonable, and affordable rates. The Joint Board recommends that the states exercise primary responsibility for determining the affordability of local service rates within their respective jurisdictions.

Virtually all parties agree that a state universal service funding mechanism is necessary to ensure the availability of telephone service at just, reasonable and affordable rates to all residents of the Commonwealth. OCA Main Brief at p. 3. PTA states that the creation of a state funding mechanism is necessary to provide "a safety net on consumer prices and assure continuing affordability. See, PTA Main Brief at p. 4.

This is supported by the results of the various cost studies and the data in the record of this proceeding. For instance, Bell states that the BCM calculated that Bell's costs to provide BUS would be between $11.36 and $105.48 per-line per-month. The GTEN study showed that the monthly cost to provide residential universal service in GTEN's serving area varies from $17 to $91 per-line. These same wide variations in exchange BUS costs are seen in the study results pertaining to other LECs also.

Arguments that in the aggregate there is no subsidy, since for instance Bell's revenues from its local exchange service exceed the incremental cost of providing that service, miss the point. The record in this proceeding substantiates the fact that while there may be no subsidy in the aggregate, the rates for BUS elements in some areas of the state do not cover their costs, and therefore, implicit subsidies exist to keep local rates affordable. Bell agrees that while there may be substantial disagreement over how BUS costs should be calculated, almost all parties agree that costs in the least dense areas of the state are substantially more than the costs in more heavily populated areas of the state, and that rates in the least dense or rural areas of the state in particular do not cover their costs in many instances.

The need for universal basic telephone service is particularly acute in rural areas of the state, however, as illustrated by OCA witness Brockway's testimony that:

the median OPASTCO respondent lives 15 miles from a hospital and 13 miles from a doctor -- 25% live more than 20 miles away from either -- a serious problem for the 21% of rural residents who are chronically ill and the 10% who are disabled. This is especially problematic for the 30% of respondents who are elderly, 35% of whom suffer from chronic illness and 35% of whom are disabled.. (In the rural age 55-64 bracket, 24% are chronically ill and 24% are disabled.) Low-income people are also particularly vulnerable -- 39% of rural respondents with incomes below $10,000 suffer from chronic illness and 29% are disabled. (A quarter or more with those with incomes below $30,000 are chronically ill).

One of the primary purposes of the state funding mechanism, is to compensate carriers for undertaking the obligation to provide service at a price found to be acceptable from a public policy perspective, where this required price is less than a price that would have been implemented in a competitive market, as it will be in all high cost, rural areas of the state. GTEN Stmt. 1.1 (Williams) p. 11.

B. To Maintain and/or Increase Subscribership Rates In All Areas of the Commonwealth

According to both the OCA and PTA, universal service has not been achieved in Pennsylvania. OCA Stmt. 2.0 (Brockway) at 25; PTA Main Brief at p. 33. The OCA notes that according the current population survey data collected from FCC Monitoring Reports, the rise in penetration since the early 1980's has tapered off. OCA witness Brockway testified that while current overall telephone penetration in Pennsylvania is high (96.8%) relative to the rest of the country, telephone penetration in Pennsylvania has been declining since 1993 and will decline more sharply if basic rates increase. OCA Main Brief at p. 33. From 1993 to 1995, penetration rates have dropped from 97.3 to 96.8 percent. OCA Stmt. 2.0 (Brockway) at 21. While this may not seem like a lot, each percentage point equates to hundreds of households without telephone service. Brockway also testified that the difference between the current Pennsylvania penetration rate and the national average rate represents roughly 39,450 households. OCA Stmt. 2.1 (Brockway) at p. 12.

OCA witness Brockway also testified that the penetration rate of 97+ percent that is often cited for the proposition that universal service has been achieved in Pennsylvania, is not a consistent number, and in any event does not show the whole picture. While some populations may have extremely high penetration rates, low-income households, particularly low-income renters, have low penetration rates. Penetration rates for low-income African-Americans and Hispanics are exceptionally low. Significantly, the rural areas of the state also have penetration rates below the statewide average. OCA Stmt. 2.0 (Brockway) at p. 26.

AT&T witness Darrah, among others, testified that "[o]verhauling the current system will result in at least two major benefits to all Pennsylvanians. First, it will stimulate competition in Pennsylvania's long distance, toll and local markets. Second, it should increase the level of subscribership in Pennsylvania even beyond its current levels." AT&T Stmt. 1.0 (Darrah III) at p. 11. With the introduction of competition in heretofore monopoly markets and in light of the requirements of the Federal Act, the old rules will no longer work to ensure high subscribership in Pennsylvania, particularly in rural areas of the state. The record supports the establishment of a state universal service funding mechanism to ensure that subscribership rates are maintained or increased as the prices for all services are more closely aligned with their underlying costs. Given the compelling testimony of witness Brockway, it is also needed to increase penetration in areas or among households of the state where penetration is below the statewide average.

C. To Encourage Competition In Urban and Rural Areas Alike and All Telecommunications Markets in Pennsylvania

As the following discussion illustrates, the state funding mechanism will promote competition in two ways. First, it will encourage competition in both urban and rural areas in Pennsylvania. The record evidence establishes that the funding mechanism will ensure that rural Pennsylvanians receive the benefits of competition to the same degree as urban residents of the Commonwealth. GTEN notes in this regard that a state universal service funding mechanism is necessary to create the possibility of competition in high cost areas where residential local exchange service is priced below cost. GTEN Reply Brief at p. 20. At present, the "current rate structure discourages competitive entry in the less dense areas of the state where costs to provide service are higher, and incumbent LECs' rates are below cost." Bell Stmt. No. 3.2 (Emmerson) at 2-4. Without reform in this area, including the establishment of a state universal service funding mechanism, competition will "continue to struggle for a foothold even in urban markets, and it is unlikely to develop at all in the rural or so-called 'high cost' markets."

Second, the funding mechanism will act not only to ensure competition in high cost and low cost areas alike but will also act to encourage effective competition in all of the various telecommunications markets in Pennsylvania. While the record demonstrates that there are subsidies in existing rate structures; the direction of the subsidies has not been clearly established in all cases. The one area, however, where there is virtual unanimity of opinion is that intrastate switched access charges must be reformed. AT&T argues that the current system artificially maintains high prices for long distance calls by maintaining carrier access charges at levels that greatly exceed their relevant costs. AT&T witness Darrah testified that Bell's carrier access charges while set lower than those charged by other Pennsylvania ILECs are nearly 30 times the incremental cost of providing access services. AT&T Main Brief (citing AT&T Stmt. 1.0 (Darrah III) at 5-6. We agree that reform is critical in this area particularly in light of the fact that in 1997, we will begin implementing 1+ presubscription in the intraLATA toll market. This will allow residents in the Commonwealth to access any competitive interexchange carrier in Pennsylvania for the purpose of making in-state toll calls, by dialing 1+ the number of the called party. However, in order to encourage meaningful competition in this area, access charges must be more reflective of their actual costs.

Moreover, Pennsylvania consumers will soon begin to realize the benefits associated with competition in the local service market. On October 4, 1995, the Commission certified four CLECs to begin providing competitive local exchange service in Bell's service territories.⁽⁶⁾ The Commission has since certified other carriers to provide local exchange service in Pennsylvania in competition with the ILEC. Elimination of implicit subsidies now inherent in existing local rates is necessary to pave the way for effective competition in local markets in Pennsylvania.

D. To Achieve Regulatory Parity Between Incumbent and New Providers

There is also almost virtual unanimity that the new telecommunications environment requires that subsidies, if any, in existing rate structures be eliminated. Most parties agree that subsidies that are currently implicit in existing rates are nonsustainable in a competitive environment. Sprint United Reply Brief at 2. (citing Sprint/United Main Brief at pp. 6-20; BA-PA Main Brief at pp 14-36; GTEN Main Brief at pp. 3-123, 20-27; PTA Main Brief at pp. 8-13, AT&T Main Brief, pp. 4-32; MCI Main Brief, pp. 13-18; OCA Main Brief p. 3; and OTS Main Brief at pp. 31-32.

As just discussed, traditionally residential rates have been maintained at affordable levels through implicit subsidies inherent in company rate designs and contributions from the separations process and the federal funding mechanisms. However, those subsidies are only available to incumbent providers at the present time. Virtually all parties participating in this proceeding agree that the present system is anti-competitive because no new providers can enter the local exchange business and compete when only the incumbent LECs are receiving the subsidies. See, AT&T Reply Brief at p. 8. Reform is needed so that the system that is established will be competitively neutral to all providers. Sprint/United Reply Brief at p. 3.

On the other hand, GTEN points out that the funding mechanism is also necessary to create "regulatory parity" for incumbent providers. GTEN Reply Brief at p. 20. It notes that incumbent providers have generally faced asymmetric obligations pertaining to service and pricing constraints. GTEN Stmt. 1.1 (Williams) at p. 13. GTEN discusses a recent paper by Dr. Mark Schankerman from the London School of Economics which emphasized the importance of symmetry in regulation as the linchpin to the attainment of the maximum consumer benefits from competition. GTEN St. 1.1 (Williams) at p. 13.

E. To 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"

The funding mechanism will act to promote economic development in all areas of Pennsylvania by facilitating telecommunications "parity" in urban and rural areas alike. The mechanism will also promote infrastructure development in rural Pennsylvania consistent with the TA-96 and Chapter 30 of Public Utility Code.

OCA witness Brockway testified that to the extent network modernization is intended to benefit rural areas, these benefits are lost if rural customers cannot afford basic exchange service. High prices for basic rural service would also have a negative impact on employment. OPASTCO also found that more than a third of rural business respondents either said they would consider relocating to avoid a 25% telephone rate increase or could not rule out such a move. OCA witness Brockway opined that this is an implied loss of jobs that rural Pennsylvania could scarcely afford. OCA Stmt. 2.0 (Brockway) at p. 28.

The funding mechanism is important to assist in ensuring that the universal service requirements of the Federal Act and the requirements of Chapter 30 relating to comparability of service between rural and urban areas of the state are met.

F. To Achieve More Effective Targeting of Existing Subsidies

In order to maintain universal service in a competitive environment, subsidies that are embedded in current rates must be explicitly identified and targeted to high cost census block group areas. Sprint/United Reply Brief at p. 1.

AT&T witness Mayo testified as to overall ineffectiveness of the current system:

The mechanisms that exist today for promoting universal service in Pennsylvania are structured in a manner completely opposite from the ideal. Rather than being narrowly targeted and broadly funded, they are broadly targeted and narrowly funded.

AT&T Main Brief (citing AT&T Stmt. 1.0 (Darrah III) at 4-5; AT&T Stmt. 2.0 (Mayo) at 23).

AT&T also argues that the present system of subsidies is problematic in that subsidies are being distributed without regard to need or cost. Under the present system of "implicit" subsidies, when low income residents in the City of Chester make toll and long distance calls, they may very well be subsidizing below-cost local service for affluent residents in Chester County. AT&T Reply Brief at p. 8.

While the LifeLine program is available to low-income customers residing in Bell Atlantic service territories, Lifeline is not available in the service territories of any other LECs in Pennsylvania. Additionally, the use of Lifeline type programs will not prevent the loss of service as a result of basic exchange price increases due to the elimination of implicit subsidies. OCA Stmt. 2.1 (Brockway) at 22; OCA Main Brief at p. 48. These programs are designed to mitigate rate increases for low income subscribers, not prevent rate increases for the great majority of customers. OCA Main Brief at p. 48. The Pennsylvania state universal service funding mechanism targets and ensures affordable rates for the vast group of customers living in the high cost, rural areas of the state in the future. OCA witness Brockway testified that 31% of the approximate 4.7 million Pennsylvania households are in rural areas. OCA Stmt. 2.0 (Brockway) at 55-6; OCA Main Brief at p. 35.

By making all subsidies explicit in the future and by targeting those subsidies to high-cost areas only, the state universal service funding mechanism will ensure that those subscribers who need the subsidies actually receive them.

G. To Encourage Carriers to Meet the Mandates of Chapter 30

Chapter 30 of the Public Utility Code establishes a pro-competitive, deregulatory framework for telecommunications services in Pennsylvania, much like the framework subsequently adopted by Congress in the Federal Act for the regulation of telecommunications services nationwide. Indeed, Chapter 30 and the Federal Act share many common objectives including the promotion of regulatory reform, infrastructure modernization and universal service.

However, tensions between the primary objectives of competition, universal service and infrastructure modernization, make the successful attainment of one goal without sacrificing the other difficult, necessitating policy reform. The mechanism created today will bridge the gap and allow companies to develop infrastructure while at the same time encourage effective competition since the mechanism is set up to benefit all carriers not just the ILEC. While accomplishing all of this, the mechanism's primary purpose will be to assure affordable rates in all areas of the Commonwealth. Our decisions today are guided in large part by our continued commitment to achieving and ensuring compliance with Chapter 30's objectives in a timely manner. There is no more effective way of accomplishing Chapter 30's many mandates than through a state universal service funding mechanism.

H. To Carry Out and Comply with the Mandates of TA-96

The TA-96 provides for the establishment of both state and Federal funding mechanisms. It is contemplated that the Federal fund will cover only a portion of the carrier's costs. The Federal Act contemplates that state funds will be available to assist in high-cost areas and to offset the high cost of providing services in each state and any additional services which the state determines should be part of its definition of universal service.

Additionally, the Federal Act requires states, with respect to intrastate services, to ensure affordable access to and use of such services by educational providers and libraries. See § 254(h)(1)(B). The Universal Service Task Force established today will be responsible for making recommendations to the Commission on the provisions of § 254 relating to educational providers, libraries and health care institutions taking into account the recent Joint Board Recommended Decision. Our obligations under the Federal Act in this regard can best be accomplished by the establishment of a state funding mechanism. Without a state funding mechanism, the partnership envisioned by Congress in the universal service area will be impossible to accomplish. The Federal Act, through the dual and equal roles given to state and Federal regulators in this area, recognizes that each must play a role in the future to ensure universal service.

I. Alternatives Not Viable

1. Play or Pay

a. Position of the Parties

While virtually all parties to this proceeding supported the establishment of a state universal service funding mechanism, one carrier, Bell, proposed an alternative. Bell, argues that its carrier of last resort ("COLR") responsibilities and universal service obligations will put it at a distinct competitive disadvantage. Bell Main Brief at p. 52. In return for undertaking its COLR obligations, Bell advocates what it calls a "play or pay" system which would distinguish between local exchange providers which provide universal service and those which do not. It would do this through the ILEC's interconnection rate structure by imposing higher interconnection rates on nonplayers, or those who do not undertake COLR responsibilities. The "play or pay" plan would permit all carriers' providing universal service to charge a penny per minute surcharge to nonplayers, which is the amount of the Company's current CCLC. Main Brief at p. 53 (citing Bell Stmt. 5.1 (Eichenlaub) at 18-19; Bell Stmt. 4.0 (Mitchell) at 9).

Bell argues that this system would ensure that "all carriers contribute to universal service either by serving high-cost or Lifeline customers or by paying a universal service rate component to those carriers who do serve these customers..." Bell Main Brief at p. 52. Bell explains it proposal in the following excerpt:

This structure requires both the new entrant and the incumbent LEC to meet their obligations to support the provision of affordable service in high cost areas either by being a facilities-based provider or in cash -- eg., either by actually serving its pro rata share of high cost and Lifeline lines (being a "Play"), or by supporting the other carriers' service to those lines by paying the LECs and CLECs in the service territory that are actually serving high cost and Lifeline lines (being a "Payer"). To be considered a player, a CLEC would have to serve a percentage of high-cost and Lifeline lines comparable to the incumbent's percentage.

Players would charge other players only the local termination rate, which Bell advocates should be current switched access rates minus the CCLC. Bell Main Brief at p. 53.

No party supported Bell's "play or pay" proposal. Teleport Main Brief at p. 34. (AT&T Stmt. 1.2 (Darrah) at 15; Sprint/United Stmt. 1.3 (Jamison) at 13, MCI Stmt. 2.0 (Ankum) at 2-26; ETC Stmt. 1.1 (Murray) at 4-14; OCA Stmt. 1.2 (Johnson) 34-35; OTS Cr. Ex. No. 3 at 3; OSBA Stmt. 1 (Levin) at 8; GTEN Stmt. 6.1 (Vogel) at 5; MFS Stmt. 1.1 (Ball) at 8-13).

Both Teleport and MFS argue that "play or pay" violates multiple provisions of the Telecom Act, including §§ 252(d)(2), 253(a), 254(b)(5) and 254(f). MFS states that the concept of linking universal service charges directly to local call termination rates is contrary to the Act. MFS Main Brief at p. 7. AT&T agrees with MFS that the "play or pay" proposal violates several provisions of the Federal Act including the nondiscrimination requirements of 47 U.S.C. § 254(b)(4) and the specific, predictable and sufficient requirements of 47 U.S.C. § 254(b)(5).

AT&T witness Mayo also testified that the "play or pay" plan would "create a fundamental asymmetry in interconnection rates between ILECs, which are "players," and new entrants, which are "payers:"

Specifically, for firms that are deemed to be 'payers,' the price paid to ILECs for terminating interconnection would be substantially higher than the rate that these new entrants would collect for providing exactly the same terminating interconnection service to the ILECs. This raises at least two anti-competitive concerns. First, BA-PA's POP plan advocates a set of fundamentally different prices that are established independent of cost differences. Thus, the plan would seek regulatory permission for discriminatory pricing. Not all price discrimination is anti-competitive, especially to the extent that such discrimination has the effect of raising industry output. In the case of the POP plan, however, the sole effect is to raise the cost to new entrants of interconnecting with incumbent local exchange providers. This can hardly be seen as a pricing tool to expand industry output. Thus, the discriminatory features of the plan are troublesome.

AT&T Stmt. 2.0 (Mayo) p. 13.

AT&T also asserts that the "...essence of ...[Bell's] scheme is a discriminatory and inequitable contribution mechanism imposed entirely on the new entrants, with no contribution from the ILEC 'Players.'" AT&T states that in contrast to a broadly-funded, explicitly targeted universal service fund, the burdens of the Bell "play or pay" scheme would be borne by a narrow set of "payers" -- that is those few new entrants who could overcome the barrier to entry that the scheme would impose and would not be targeted at all. AT&T Main Brief at p. 34.

Teleport argues that with or without the CCLC add-on, Bell's proposal is not based on cost. Teleport Main Brief at p. 34. Teleport also argues that Bell's "play or pay" not only creates a barrier to entry, but also places CLECs in a price squeeze. MCI witness Ankum testified that "play or pay" would not promote an efficient telecommunications infrastructure for Pennsylvania. MCI Stmt. 2.0 (Ankum) at p. 12.

OCA witness Johnson also testified that Bell's proposal would have an adverse impact upon competition:

Proposals like Bell Atlantic's "pay or play" scheme will make niche marketing more difficult, create increased risk and uncertainty, and force new entrants to look like the incumbent LEC. These proposals will tend to create barriers to entry, and potentially slow the transition to effective competition. In contrast, a well designed plan would actually lower barriers to entry, by unbundling the dominant LEC's services at reasonable prices, and by offering financial support to carriers that serve low income consumers, and residential customers located in unusually high cost areas.

OCA Stmt. 1.2 (Johnson) at p. 37.

Bell urges that its proposal is consistent with the Federal Act since it is based on a switched access rate which this Commission found to be just and reasonable. Bell Main Brief at p. 1.

b. Discussion

We agree with the majority of parties in this proceeding that Bell's "play or pay" proposal may be inconsistent with several provisions of the Federal Act and is not competitively neutral. We take note in particular of the following list of concerns expressed by AT&T:

(1) it would permit the continuation of embedded subsidies, and add another one, rather than making such subsidies explicit.

(2) all subsidy flows would go directly to the "Players" -- in other words, the incumbent LECs -- rather than being targeted to all carriers willing to serve "high cost" areas and those consumers who could not afford telephone service in an open and competitive market.

(3) the subsidy would not be portable among local service providers -- i.e., all subsidies would follow the ILEC, not the customer.

(4) the subsidy would be collected and disbursed by the "Player," not by a neutral third party.

(5) the subsidy would be funded narrowly, and,

(6) the system would act as a barrier to competitive entry in the local exchange market.

Further, we cannot put our stamp of approval on a proposal which would allow any carrier to charge current switched access rates for local interconnection, including a universal service charge, equivalent to the existing CCLCs of carriers. The record before us today demonstrates that the CCLC is not cost-based and Bell's proposal to impose the CCLC upon CLECs would only exacerbate the level of hidden subsidies which LECs claim are prevalent in their existing rate structures. While Bell argues that its switched access rates were recently determined to be just and reasonable, the reasonableness of those rates for termination of CLEC local traffic has never been determined by this Commission.

Finally, we also note that the FCC recently found that "play or pay" schemes violate multiple provisions of the TA-96.⁽⁷⁾ The FCC also held that states may not include universal service support funding in the rates for elements and services pursuant to sections 251 and 252, nor may they implement mechanisms that have this effect. Id at para. 713. ("We conclude that funding for any universal service mechanisms adopted in the universal service proceeding may not be included in the rates for interconnection, network elements, and access to network elements that are arbitrated by the states under sections 251 and 252") Id. at para. 712. The FCC reasoned that including non-cost based charges in the rates for interconnection and unbundled elements is inconsistent with the mandate in § 254(f) that telecommunications carriers contribute to state universal service on a nondiscriminatory basis. First Report and Order at para. 712. ("We conclude that permitting states to include such costs in rates arbitrated under sections 251 and 252 would violate that requirement by requiring carriers to pay specified portions of such costs solely because they are purchasing services and elements under section 251"). The FCC also found that the "play or pay" scheme violated § 252's requirement that interconnection rates be cost-based.

In conclusion, the anti-competitive concerns identified by various parties surrounding Bell's "play or pay" plan significantly outweigh any of the proposal's suggested benefits. Consequently, we do not find, based upon the extensive record in this proceeding, it to be a viable alternative to the establishment of a state universal service funding mechanism in Pennsylvania.

2. Rate Rebalancing

a. Position of the Parties

Bell argues that rate rebalancing is the most economically efficient method of solving the universal service issue. Bell Main Brief at p. 4. Bell filed a rate rebalancing proposal as part of this proceeding. Bell witness Sanford testified that Bell's entire universal service subsidy could be eliminated by dialtone line increases that are significantly below the $25 BUS rate. Bell Reply Brief at p. 33.

Most other parties, including Sprint/United and GTEN, support rate rebalancing along with the establishment of a state universal service funding mechanism. Further, all parties with the exception of Bell, also agree that rate rebalancing is not an effective substitute for the universal service funding mechanism. Some parties argue further that Bell's proposal to increase local exchange rates in high cost rural areas under the rubric of rate rebalancing will if anything potentially erode universal service which is the very problem that a universal service fund is designed to alleviate. They also argue that Bell's rebalancing proposal would do little or nothing to stimulate competition in high cost rural areas since subsidies for the provision of service in these areas would continue to be available only to Bell through its internal monopoly support mechanism, and not to new competing carriers.

The OCA strongly opposes the rebalancing proposals of Bell and GTEN submitted in this proceeding. OCA argues that the rate rebalancing proposed is merely a technique to enable LECs to reduce rates in areas or for services that are subject to competition, without unacceptable earnings erosion. OCA Stmt. 2.0 (Brockway) p. 65. OCA further argues that the discussion of rate rebalancing "puts the cart before the horse." OCA notes that the focus on rate rebalancing is premised on the likelihood of some level of need to supplant lost streams of earnings as the result of competition. OCA goes on to state that this Commission should not assume that there will be any lost earnings on net as a result of competition. Id. at 66. Brockway states that while some telephone companies may lose market share and revenues, these same companies are equally likely, if not more likely, to find new markets and new services to deliver earnings in the future. OCA cites to Bell's entry into the interLATA toll, cable and video markets. OCA Stmt. 2.0 (Brockway) at pp. 67-68.

Bell replies that its proposed rate rebalancing is not designed to and will not compensate Bell for the erosion of revenue which will occur as competition in the local and intraLATA markets intensifies. Bell Reply Brief at p. 34. Bell argues that the OCA's assertions about the impact of increases in the price of BUS must be dismissed, as the evidence supporting those assertions is seriously flawed. Bell argues that the Commission should accept Mr. Raimondi's and Mr. Perry's analyses which show that Bell's proposed rate rebalancing would have no negative effect on subscribership levels in Pennsylvania and should approve LEC rate rebalancing as the only way to reduce the size of the universal service subsidy. Bell Reply Brief at p. 34.

b. Discussion

This Commission recently rejected Bell's general rate rebalancing proposal which proposed a $42M increase (after proposed offsets) to residential dialtone rates alone. Bell justified its primarily rural residential rate increase stating that urban residential rates allegedly subsidized rural rates and that business rates allegedly subsidized residential rates. The Commission found that the studies submitted by Bell were flawed and did not clearly establish that the alleged subsidies actually existed. Similarly, the record in this proceeding does not support either Bell's or GTEN's rate rebalancing proposals, much less the proposition that Bell's plan would eliminate the need for the state funding mechanism. While the record is clear that the BUS rates in rural areas of the state do not in many instances cover their costs, the direction of any cross-subsidy, and the need or ability to increase BUS rates without deleterious impacts upon subscribership levels in some areas of the state has not been established with certainty.

In particular, we give considerable weight to the testimony of OCA witness Brockway as to the adverse consequences upon primarily rural areas in Pennsylvania if we were to accept Bell's position. Census data shows that 31% of Pennsylvania households live in rural areas. Brockway testified that rate rebalancing is more likely to affect rural customers, where distances from the central office put pressure on average loop costs. OCA Stmt. 2.0 (Brockway) p. 56. Brockway stated that as many as 1,481,837 households are at higher risk of rate rebalancing simply by virtue of living in rural areas. Id. Brockway also testified that for rural customers, rate rebalancing would constitute a double disadvantage, no competition for years to come and a rate increase. OCA Stmt. 2.0 (Brockway) at p. 72

OCA witness Brockway testified that at the increase proposed in Bell's January 8, 1996 rate rebalancing proposal for Cell 4, Usage Rate groups A through C, without TouchTone (assuming Local Area Unlimited Option Usage Package), and assuming Mr. Raimondi's elasticity estimates, from 1% to as many as 3% of such customers could lose service. OCA Stmt. 2.1 (Brockway) at p. 6. Brockway also correctly pointed out that toll usage may not be a luxury for some rural customers. The longer the distance from home to family, friends, work, school, shopping, medical care and the like, the more important the toll usage. OCA Stmt. 2.1 (Brockway) at p. 29.

Further, we agree with those parties who argue that rate rebalancing is not an effective substitute for the universal service funding mechanism at issue before us today. It was never contemplated by this Commission that rate rebalancing would replace the need for a state universal service funding mechanism. The purpose of rate rebalancing is to more closely align prices with costs in a competitive marketplace. However, we cannot condone its use when the ultimate result will be to force customers off the network. While this Commission has thus recognized that some rate rebalancing by ILECs to be able to compete effectively in the new market may be appropriate, as long as reasonable and cost justified, we would be ignoring our mandates under both Federal and state law if we were to allow increases to BUS which threatened the ability of rural customers to have access to basic telephone service.

Unlike rate rebalancing, the primary purpose of the state universal service funding mechanism is to ensure affordable rates in the future, particularly in the rural high cost areas of the state. Traditionally, as already discussed, this goal has been achieved through a combination of implicit and explicit subsidies. In addition, many Pennsylvania carriers receive funds from certain Federal mechanisms, including DEM Weighting, the High Cost Fund and the Long-Term Support Fund. Together, these various subsidy flows were sufficient to ensure affordable rates in most areas of Pennsylvania. With the changes to the Federal universal service funding mechanisms, and the elimination of implicit subsidies in Federal access charges, much more pressure will be placed on local service rates, particularly the rates of rural, high-cost residential subscribers. The support flows that carriers relied upon will no longer be available at all or to the same degree. The increasingly competitive marketplace, pressure for reduced assistance through the federal mechanisms coupled with the elimination of implicit subsidy flows, necessitate this action on our part today in order to ensure that the local service rates in all areas of Pennsylvania remain affordable.

Given these considerations, we do not find rate rebalancing an effective substitute for the BUS funding mechanism. Rate rebalancing will lead to exactly the result we desire to avoid through the establishment of the universal service funding mechanism. We desire to avoid the result where competition in urban markets puts pressure on rates to increase in rural markets to the point where some customers will be forced off the network. We do not find this result viable nor do we sanction a result where only one class of subscribers, those residing in urban markets, receive the benefits of competition which would be the result under any rate rebalancing proposal. The universal service funding mechanism will eliminate the adverse ramifications which could stem from rate rebalancing, where necessary, and will also allow this Commission to meet the universal service and/or subscribership objectives of both the TA-96 and Chapter 30. We further find that no amount of rate rebalancing will help the small ILECs in Pennsylvania which serve principally high cost exchanges. In some rural exchanges, rates reflective of cost would result in increases five to seven fold at times. The result is intolerable and antithetic to the very principle of universal service.

3. Maintenance of the Status Quo

This is referred to by some parties as the "wait and see" approach. We do not find this to be a reasonable or viable alternative in light of the many changes occurring in the industry. Bell argues that the Commission should not establish a universal service fund at this time since it may not be required at all if Bell's rate rebalancing and "play or pay" proposals are implemented. Bell Reply Brief at p. 35. However, as already discussed, neither rate rebalancing or "play or pay" present viable alternatives to the establishment of a universal service fund in Pennsylvania. We agree with the majority of industry participants that the Commission should not take a "wait-and-see" approach, but should act immediately to establish the appropriate ground rules for universal service. GTEN Stmt. 1.1 (Williams) p. 12.

Establishment of the appropriate ground rules for universal service will provide the necessary impetus to competitive carriers to enter all markets in Pennsylvania, ensuring that all Pennsylvanians receive the benefits of competition.