Alternative Model for Universal Service Funds

1. Alternative Model for Universal Service Funds Vince Wiemer, Principal

2. Introduction • Alexicon advises its clients on rate-of-return regulation, universal service funding, intercarrier compensation, and interconnection issues among other services. • Alexicon’sclients include privately-owned, municipal, co-operative, and Tribal companies in eleven states and represent communities ranging from 250 to 40,000 access lines. • Co-authored the White Paper: Lessons from Rebuilding the FCC’s Quantile Regression Analysis. • Authored FCC Rate-of-Return Represcription Comments on behalf of 160 rate-of-return rural ILECs.

3. The Big Issues - USF • Focus USF on broadband • Reduce waste and inefficiency to control size of USF • Incentive-based policies to promote IP networks • Accountability • Recovery of past USF investments • Sufficient and predictable support mechanisms • Sustainable economic model • Administrative burden FCC Goals RLEC Concerns

4. History Lesson: RLEC USF ISSUES • Rate-of-return = gold plating • USF fund size is too big • Old ways can’t meet new goals • Rural investment vs. Big LEC profits • FCC blew up USF with CETC identical support and changing CL recovery • LSS and HCL largely responsible for the deployment of broadband in RLEC areas FCC Perception

5. Cost Causers & Incentives • Broadband costs include: • Switching & routing • Central office, field, and customer premise electronics • Loop costs • Bandwidth access (“middle mile”) • FCC Reforms are disincentives for broadband investment • Zero recovery of switching investment • Zero recovery of broadband-specific electronics • Reduced recovery of common line costs • Zero recovery of bandwidth access costs

6. FCC Goal Accomplishment • Focus USF on broadband • Reduce waste and inefficiency to control size of USF • Incentive-based policies to promote IP networks • Accountability • None • End CETC identical support; reduced fund size; cost benchmarks • None • Many required reports and certifications FCC Goals Method

7. History Lesson : COST RECOVERY “Those who cannot remember the past are condemned to repeat it.” - George Santayana Reason in Common Sense

8. Alexicon Broadband Plan • Broadband High Cost Loop Fund (BHCL) • Include broadband plant categories in current HCL algorithm • Eliminate CETC identical support and safety net additive • Eliminate §54.305 “parent trap” rule so acquired exchanges have same investment incentives • Interstate Common Line Support Reform • Lower access rate and move remaining TS revenue requirement to ICLS recovery (maintains RoR mechanism) • Recovers IP switch investment and some middle mile costs • Middle Mile Support • Include as transmission expense to allow recovery through BHCL and rate-making • Revised Local Switching Support • Ratchet down DEM weighting to support <15,000 lines

9. Broadband High Cost Loop Include broadband equipment categories in BHCL calculation • Cat 4.11 WB Exchange Circuit - Interstate • Cat 4.22 WB IXC Circuit - Interstate • Cat 2 WB CWF - Interstate

10. BHCL Algorithm (cont’d)

11. BHCL Considerations Economically sustainable model • New broadband NACPL developed as a threshold • Eliminate CETC identical support & Safety Net Additive • Acquired exchanges receive full support • No additional record-keeping required • Provides proper investment incentives Flexibility and Accountability • Funding thresholds (65% / 75% ) • Special Access adjustment calculated to avoid double recovery of broadband costs • Works with a capped fund and corporate ops expense limits • Can assign different weighting to investment and expense categories

12. Interstate Common Line Support Modify the current MAG shift to move portion of switched access to common line • Lowers access rates while maintains RoR recovery • Can target an access rate for carriers or move % • Provides flexibility in fund sizing • Can still use corporate ops expense limits • Works with modernized traffic measurements  Common Line from 25% to 33% interstate • Shifts costs $475M from state to interstate jurisdiction • Aids efforts for state / interstate parity

13. Goal Accomplishment • Focus USF on broadband • Reduce waste and inefficiency • Incentive-based policies to promote IP networks • Accountability • Include broadband costs in USF mechanisms • End CETC identical support; reset BNACPL • Proper incentives: broadband=support; End “parent trap”; Targeted LSS • Current certifications; SpA recovery adjustment FCC Goals Alexicon Plan

14. Concerns Addressed • Recovery of past USF investments • Sufficient and predictable support mechanisms • Sustainable economic model • Administrative burden • Past investments included in BHCL • As predictable as legacy HCL; sufficiency is a separate issue • Retains RoR; provides proper incentives; lowers access rates • Little added burden RLEC Concerns Alexicon Plan

15. History Lesson: COST MODELS Predictive models are only as good as the input data and cost relationships established (GIGO = garbage in, garbage out) • QRA:Flaws in 14 of 16 predictive variables; no cost causation • CACM:~40M of ~135M homes aren’t in the location databases and are placed randomly FCC models repeatedly fail real world tests • QRA:incorrectly found Alaska capital costs to be 46% less than the lower 48 states • CAF: $775 per household is not enough to incent broadband investment; $185M of $300M (62%) of CAF Phase 1 Support went unused Best method and/or use of resources? • Is there a better predictor than actual historical cost data?

16. Questions?