The inter-carrier compensation scheme is a mess. On this all parties agree. Over the years, the U.S. Federal Communications Commission (FCC (News - Alert)) moved from the role of regulator overseeing compensation payments that were enforced through tariffs between carriers to becoming a collector and distributor of billions of dollars of collected funds. There is little agreement on how to implement a new process that is equitable and politically palatable. Carriers and Commissioners are polarized by the proposals for reform.

 

On October 28, FCC Chairman Martin put “comprehensive reform” of inter-carrier compensation on the November 4 FCC agenda. The reason the FCC was tackling this controversial topic on election day was because the D.C. Circuit Court of Appeals had issued an order in Core Communications holding that if the FCC did not issue an order by November 5 addressing the narrow inter-carrier compensation matter arising from the 2001 ISP Remand Order covering dialup ISP traffic, the FCC’s ISP Remand Order would be vacated. The Court required the FCC to provide the “legal reasons” for finding that Internet service provider (ISP) dial-up traffic is not subject to reciprocal compensation required by the 1996 Telecommunications Act.  

 

 

On November 3, the Commissioners came public with press releases revealing a split between Chairman Kevin Martin and the other four commissioners. Martin’s reform proposal had been blocked by all his fellow Commissioners. Why did this divisiveness appear? The two Republican commissioners, Robert McDowell (News - Alert) and Deborah Tate, who have loyally stuck with Martin, split with him over inter-carrier compensation reform.  Was this because both Martin and Tate are on their way out the door, or were there other reasons?  

 

Once blocked, Martin issued a revised agenda removing the reform item from the November 4 agenda. The other Commissioners countered with a press release explaining that they were proposing an alternative order that would a) allow for proper rulemaking notice and comments on comprehensive reform and b) narrowly address the Core Communication court remand. The Commissioners’ press release expressed their frustration with the Chairman:

 

 

Chairman Martin countered immediately with his own press release conveying his displeasure:

 

 

Martin also countered with comments that will provide any party appealing the Core Communications order with sufficient ammunition to have the FCC’s order overturned:

 

 

The drama continued late into the evening on November 5, as the FCC released a 430-page order narrowly answering the D.C. Appeals Court order and addressing comprehensive reform in a notice of proposed rule making. Martin, on the losing end of this struggle, released another critical statement:

 

 

Martin provided further ammunition for overturning the FCC’s narrowly crafted Core Communications order:

 

 

Martin is right. The current inter-carrier compensation system is complex and messy. Even many in the telecom industry do not know about the various fees and subsidies.  

 

 

A little back-story is needed to understand the origins and, thus, proposals for reform.  In 1983, at divestiture, the FCC created the system of subsidizing local exchange companies to ensure universal service through direct payments from inter-exchange carriers (IXCs) to incumbent local exchange carriers (ILECs) based on each minute terminated. These payments, set forth in the ILEC access tariffs, are based on end office and tandem costs. ILECs collect and keep the IXC access fees. Rural telephone companies, tasked with delivering high- cost universal service to sparely populated areas, receive a higher rate per minute than ILECs serving lower-cost, urban customers. Access tariff rates vary from $0.05 to $0.005 per minute of interstate traffic.  Intrastate IXC access rates are usually much higher. These ILEC access rates are adjusted from time to time based on a rate of return methodology.

 

In addition to the ILEC access payment, FCC authorized a flat rate recovery to allow the ILECs to collect an amount associated with the interstate cost of the end-users’ telephone loop. This “fee”, the Subscriber Line Charge or SLC, started out in 1983 at $3.50 per line and increased to $6.50 for residential lines and $9.20 for multi-business lines. Like the ILEC access payment, the ILEC collects the SLC fee each month and keeps it. The ILEC proposal for comprehensive reform, known as the Missoula Plan, recommends “dialing up” the SLC rate to $10.00 for residential lines.

 

The 1996 Telecommunications Act created even more subsidies in an attempt to evolve universal service funding from a monopolistic to a competitive industry. There were several elements involved. The well-known, “reciprocal compensation” regime was created as a per minute local exchange compensation payment between ILECs and CLECs for terminated local calls. Reciprocal compensation was similar to the “settlements” compensation paid between ILECs serving the same LATA.

 

Large ILECs had pushed for reciprocal compensation in the 1996 Act believing that most of the traffic would favor CLECs owing ILECs. The opposite happened. New dialup ISPs started delivering traffic from ILEC customers to CLECs resulting in ILECs owing the CLECs the larger balance. By 2001, the FCC saved the day by rationalizing that the local dialup ISP traffic was actually interstate in nature and, thus, not subject to local reciprocal compensation.  This is the issue FCC addressed in Core Communications.

 

The 1996 Act also created a new funding mechanism to support universal service (“USF”) in both rural and non-rural areas. Starting in 1997, the FCC established a system to collect a percentage of interstate revenues from all telecommunications service providers. The carriers are required to collect the USF fees from customers. The collected amounts are then paid to the FCC’s administrator. Once collected, the administrator doles out the USF to the needy recipients. The recipients of USF fall into three categories: 1) ILECs, CLECs, and cellco’s serving rural areas, 2) low income telephone users, and 3) schools, libraries, and health care providers. The percentage amount (now 11.3 percent) collected on interstate long distance service is calculated by the total amount of USF paid out, $6.9 billion in 2007, divided by the total annual interstate revenues received by all telecommunications service providers.

 

 

Naturally, the various proposals for comprehensive reform are constructed to meet the needs of the parties making the proposals. The ILECs and the largest IXCs, now mostly merged back with the largest ILECs, have proposed a) lowering the USF charge on interexchange service to an estimated 6 percent, b) increasing the SLC to $10, and c) charging $1.00 per end-user telephone number. Consumer advocates will not favor these proposals because charging an additional $1 per telephone number and $3 additional SLC for a residential subscriber who does not purchase long distance service will result in a “regressive” fee structure representing an estimated 25 percent increase in the total bill for some residential customers not using long distance. An additional $4 in fees on top of a $15 telephone bill equals a 25 percent increase. Thus, a user of long distance service may see a decrease while the grandmother with local service only will see an increase.  

 

What are the right answers to this political and economic conundrum? Shifting fees from IXCs to end-users based on a fee per number and increased SLC seems to be just that, shifting fees. There are nevertheless several good ideas that have been raised by the carriers and others. One proposal includes increasing the size of the high cost study areas for the larger ILECs. The study areas are used for determining the costs of rural local exchange loops. Increasing the study area size would average higher cost rural areas with lower cost urban areas causing the amount of subsidies paid to the larger ILECs to dramatically decrease. Lowering the USF payments in these high cost regions would also lower the payments to competitive providers located in the regions.

 

To the outsider, that is anyone not informed about how USF works or why it is paid, doling out $1.7 billion or 40 percent of the high cost USF to large profitable companies may seem absurd. In 2007, $1.7 billion of the $4.2 billion USF was collected for high cost incumbent and competitive provider payouts. The high cost funds made up 60 percent of the total $6.9 billion USF paid out with $2.2 billion going to schools, libraries and health care receiving and $0.7 billion for low income customers. The carriers receiving the high cost USF payments, as reported by the FCC to Congressman Waxman this summer, include: Verizon $440m, AT&T $287m, Alltel Wireless $335.6m, CenturyTel $301m, Sprint Nextel $101m, Embarq (News - Alert) $102m, and Citizens $95m.  

 

Another unique idea, advocated by Ionary Consulting, involves moving to a simpler and more equitable method of inter-carrier access. The result would require ILECs to charge a set rate for access which would vary depending on how many minutes are terminated during the month.  Each month when established IXC terminating minute thresholds are passed, the rate would decrease accordingly by an established per minute amount. 

 

Yet another proposal suggested for supporting universal service and lowering the USF fee is to impose Divesture II. This involves divesting the outside plant – central office and loops but not the switch — from largest incumbent ILECs and imposing accounting separations on the smaller ILECs for the same facilities.  Creating new, highly-regulated “LoopCo’s” would have only two purposes: 1) delivering universal service in the form of a loop to the home and 2) delivering shareholders a regulated rate of return. The LoopCo entities would be supported not by USF fees paid by end-users but by rates paid by the ILECs and CLECs for the loops and collocation space. LoopCo would not eliminate USF completely as USF would still be needed by the small rural ILECs delivering service to high cost areas. However, LoopCo would eliminate the end-user SLC and inter-carrier access compensation and would lower the USF fee percentage.  

 

An alternative concept suggests charging end-users a single percentage fee on all telecommunications purchased, both interstate and intrastate, which would decrease opportunities for arbitrage and maneuvering associated with a per telephone number fee. This method would also be equitable for the grandmother and the long distance end-user. Untangling the subsidy and fee puzzle may be difficult but it presents a great opportunity for redefining how the U.S. will ensure delivery of telephone and broadband service to all citizens.