1 USF Reform— Getting It Right, Getting it Fair Dr. Brian K. Staihr Regulatory Economist – Embarq July 16, 2007

2 Overview - Getting it Right, Getting it Fair Quick reiteration of why the need for USF support must be determined at a more granular level. Brief discussion of how this granular approach can be implemented right now… today… with no roadblocks! A couple of minutes to address what this means for reverse auction proposals and for broadband proposals. The “WHY” The “HOW”The “WHAT”

3 Paterson, Washington Monthly Cost: $ Mount Charleston, Nevada Monthly Cost: $ Waldorf, Minnesota Monthly Cost: $ Urbana, Indiana Monthly Cost: $ Ceres, Virginia Monthly Cost: $ Westville, Florida Monthly Cost: $ Iona, Missouri Monthly Cost: $ NO SUPPORT

4 Under the current system, a company’s entire territory in a state is either considered “high cost” or “not high cost”. In Missouri, Embarq receives $0 of High Cost Loop Support because costs are averaged across the entire study area.

5 Maryville $30.05 per line per month Malta Bend $ per line per month Houstonia $ per line per month Warrensburg $29.77 per line per month Study Area Averaging Masks the Existence Of Very High Cost Areas Every net-payer state has high-cost areas like Malta Bend and Houstonia that should be supported, but often aren’t.

6 Bethel, North Carolina: City Center

7 Bethel, North Carolina: Sub-wire center Wire Center Total Lines Served 1,668 Cost per Line $56.19 City Center Total Lines Served 960 Cost per Line $16.77 Outside City Total Lines Served 708 Cost per Line $109.40

8 Recently filed study on Texas USF—co-sponsored by Embarq, Windstream, CenturyTel and Consolidated—documents impacts of “donut-and-hole” phenomenon. Competitors serve only low- cost, economic, in-town areas, ignoring higher-cost out-of- town regions. Competition, rather than solving the problem, increases the need for explicit support.

9 1.Implicit subsidization exists between wire centers and within a single wire center; neither form is sustainable 2.Must re-determine which areas are uneconomic to serve; create zones within individual wire centers (donuts and holes) 3.Support is then provided to these uneconomic areas…and it’s not that hard to do! All we need is…

10 Oh no! Not…a cost model!!!

11 Yes, but it’s not your father’s cost model…

12 Increased Granularity Does Require a Model. But… Models available now that can calculate need for support at wire center (or sub wire center) levels… –Any company that has customers’ addresses and wire center boundaries can have granular costs calculated in a matter of weeks –Two years not needed to “produce” a model Commission’s past experience with model controversies is not prelude … –No repeat of the “Model Wars” of the late 90s Smaller companies—whose study areas do not exhibit variations in costs—would not require increased granularity.

13 Fund Size Can Be Controlled Even With Increased Granularity Fund size function of numerous variables, including benchmark Illustrative Example: 1.Take benchmark currently found in H.R. 2054: 2.75X national average cost 2.Apply this benchmark at a wire center level to all areas that make up wire centers served by large and mid-sized LECs 3.Support 75% of the difference between the benchmark and the cost at a wire center level 4.That amount is LESS than annual support dollars currently going to redundant competitive ETCs serving the same areas.

14 “Redundant” Support AT&T (BellSouth) Annual Receipts: > $100 Million AT&T Wireless Annual Receipts: $60 Million Alltel Annual Receipts: $36 Million Cellular South Annual Receipts: $56 Million Sprint-Nextel Annual Receipts: $12 Million Centennial Cellular Annual Receipts: $4 Million RCC Minnesota Annual Receipts: $4 Million

15 Reverse Auctions Pros –Potentially addresses problem of redundant support & fund growth Cons –Ignores problems of insufficient support built into status quo –Ignores existing COLR obligations –Ignores service quality issues –Creates new “donut” problem –Assumes “market” functions in areas where it fails –Essentially a “race to the bottom”? –In the case of wireline v. wireless, are regulators ready to force 100% of customers in an area to cut the cord?

16 And what about broadband? Areas that are uneconomic to serve for narrowband are uneconomic to serve for broadband Cannot “leapfrog” over the problem of correcting existing mechanism by focusing on broadband AT&T’s proposed “pilot” program interesting –Adjunct to, not replacement for, existing program –Need is determined at a granular level; support is targeted –Actually a form of reverse auction

17 SUMMARY – Getting It Right, Getting it Fair Current mechanism fails on two measures 1.Certain areas receive too much support 2.Certain areas receive insufficient support How do we get it right? Identify—at a granular level—the areas receiving insufficient support and support them At the same time, identify sources of redundant support and address them This can be done without losing control of fund size. How do we get it fair? Stop penalizing certain high-cost areas because they happen to be located in states with large urban areas.