Since legendary AT&T boss Theodore Vail convinced regulators in the 1930s that a regulated monopoly would best advance U.S. communications, the concept of universal service has been the driving force for the nation's telecommunications policy.

Through the explicit subsidy — and implicit subsidies included in the intercarrier compensation system — even those living in the most remote and unprofitable locations in the nation have been assured of quality phone service at prices comparable to those offered in densely populated areas. The universal service program made the telephone a ubiquitous communications tool in the U.S. and enhanced the value of the public network to all users.

For all its past success, universal service support today is at a crossroads. The current funding mechanism is inadequate and must be altered dramatically to ensure long-term sustainability. But whether the current universal service fund (USF) should be sustained is a vexing question.

During the last 20 years, U.S. policymakers have eschewed the monopoly model in favor of a telecom policy that encourages free-market competition — a notion the FCC has said is inherently contradictory with the notion of universal service.

Meanwhile, many question whether the goal of the current universal service program — affordable telephone service — is appropriate for a society that is increasingly dependent on broadband technologies. But others believe expanding universal service this way would only greatly increase the already-burdensome fund and that introducing subsidies would distort any attempts to establish the broadband free market many policymakers seek.

With so many questions surrounding the program, the one certainty is that universal service has become a front-burner issue for the FCC and Congress, with both entities indicating they will seek to resolve the complex issue during the next year.

Indeed, policymakers are almost obligated to address universal service issues quickly because it is obvious the program will collapse financially without changes. While accounting issues (see news story, page 10) and fraud allegations have grabbed headlines in recent months, the real problems are based on fundamental market changes.

Currently, USF funding is generated from charges paid by consumers who make long-distance calls. The $6 billion federal USF is bankrolled by taking a percentage — 8.9% in the third quarter of 2004 — of interstate access revenues. In addition, more than 15 states have their own complementary universal service programs that generate a combined $1.9 billion annually, according to the National Association of Regulatory Utility Commissioners (NARUC).

But long-distance revenues are shrinking. Not only are technological advances and IXC competition driving down costs, but an increasing amount of long-distance traffic is being handled through mobile wireless and voice over IP (VoIP) offerings — technologies that effectively let providers pay into universal-service programs at reduced rates.

Meanwhile, the size of the fund is growing. With the passage of the 1996 Telecom Act, the USF — once used solely to ensure that copper wires were affordable to the poor and those in high-cost areas — was expanded to fund Internet connections to schools, libraries and health-care facilities (see figure).

The decreasing funds and increasing demands on the USF have some telecom analysts comparing universal service to Social Security — a longtime sacred cow that politicians have been hesitant to address, even though the current subsidy program obviously cannot be sustained. Certainly, it's not a formula for long-term stability.

“You have decreasing revenues and increasing obligations,” said Ray Gifford, president of the Progress and Freedom Foundation. “Obviously, that's not sustainable long term.”

In addition, the USF program also stopped benefiting only traditional wireline carriers, as the FCC allowed wireless carriers to apply for the funds via requests to state commissions. But many believe state commissions have been overly liberal in granting the eligible telecommunications carrier (ETC) designations because the funding comes from the federal USF program instead of a state-supported source.

“They [state regulators] really don't have any incentive to refuse ETC applications — after all, the funding's not coming from the state, so it's like free money to them,” said one rural carrier source.

As a result, the amount of ETC funding has skyrocketed during the last five years. While this growth is a significant point of contention among rural ILECs, Western Wireless CEO John Stanton notes that wireless carriers receive only 3% of the federal USF support despite contributing 27% of the revenue into the fund — a discrepancy he believes has to change quickly.

“If the system is not fixed, we will revolt,” Stanton said during a keynote delivered at Telecom '04.

Meanwhile, the adoption of VoIP technology promises to be even more problematic. Many believe the FCC's recent decision that VoIP is an interstate service likely precludes the possibility that VoIP calls will be subject to intrastate access charges, so there would be no contributions to state universal-service programs.

In addition, the FCC must rule by March 22, 2005, whether to adopt a Level 3 Communications forbearance petition requesting that VoIP calls terminating on the public network be subject only to reciprocal compensation, not long-distance access charges that contribute to universal-service programs.

Currently, the most popular funding proposal being discussed is a numbers-based approach espoused by FCC Commissioner Kevin Martin. By charging a flat rate of $1 to every working telephone number, Martin has said enough money would be generated to address all ongoing federal USF obligations while quelling concerns that the contribution system favored one technology over another.

While that could work well for the federal USF program, there are legal questions about whether states could pursue the same approach, according to NARUC general counsel Brad Ramsay.

Courts have prohibited states from assessing state universal service changes on interstate access charges “because that's what the FCC does” to generate funds for the USF, Ramsay said. Applying the same logic to the numbers-based system could preclude states from collecting universal-service revenues via a numbering plan.

“It will be interesting to see how the FCC decides to address this,” Ramsay said. “I don't think the FCC wants to fold the $1.9 billion [in the state universal-service systems] into its program.”

Of course, the other way to resolve the USF funding concerns would be to reduce the amount of money disbursed through the programs, but there has been virtually no consensus to date. Fundamentally, most FCC commissioners have said they do not advocate the use of USF funds to subsidize competition in areas where it is difficult for even a monopoly carrier to make a return on its investment, but no specific proposal has been made public.

Rural ILEC representatives advocate stricter ETC criteria to reduce the number of carriers getting payouts, thereby reducing pressure on the fund. In addition, they believe the formula for determining payout amounts should be changed. Today, a wireless ETC receives the same amount of money per customer in high-cost areas as the wireline provider, even if the ETC's cost structure to provide service is significantly different. Rural carriers believe ETCs should be compensated based on their own reported costs.

Tom Tauke, Verizon Communications executive vice president of public affairs and communications, said he supports a policy that would eliminate ETCs altogether.

“We believe payment should be changed so that it goes only to one carrier in a given geographic territory — the carrier that would probably be designated as the carrier of last resort,” Tauke said. “We don't think it makes sense to support multiple infrastructures in an area that is hard to serve.”

But some question whether this is practical if a numbers-based collection system is adopted because cable, wireless and VoIP providers likely would object to a system in which they were required to contribute to USF but would not be eligible for universal-service disbursements.

The most formal proposal to reduce USF obligations was adopted early this year by the Federal-State Joint Board, which recommended that the FCC only provide universal-service support for the “primary” line in a given home.

After being roundly criticized as bad for economic development in rural areas and a logistical headache — determining which line is the primary line — the Senate prohibited the FCC from even considering the primary-line proposal when voting on the agency's budget.

The action underscored the power rural carriers wield in the Senate, where the membership must show sensitivity to rural issues in order to be re-elected.

“As long as two senators are elected from every state, rural carriers will be protected,” said Bill Hunt, vice president of public policy for Level 3.

And rural carriers' sentiments likely will be a central topic of discussion in future USF debates as Congress revisits the Telecom Act during the upcoming year. That's because the Senate Commerce Committee will be led by two senators from the most remote states in the union — Ted Stevens (R-Alaska) and Daniel Inouye (D-Hawaii).

In the FCC and in Congress, expect USF proposals to be linked closely to plans designed to revamp the intercarrier-compensation system. Together, these two sources generate 50% to 90% of many rural carriers' revenues.

But Beltway observers are watching closely to see where the agenda of rural carriers wanting to maintain this system and the RBOCs' deregulatory agenda collide. After all, it would be tricky for RBOCs to convince policymakers at the FCC and Congress that a deregulated broadband market should be allowed to flourish in the free market while arguing for the preservation of an explicit subsidy like universal service.

Even with support in the Senate, rural carriers may need to revamp their business plans to reduce their dependence on subsidies, according to Jake Jennings, senior vice president of regulatory and industry affairs for NuVox Communications.

“Every carrier has its addictions,” Jennings said. “CLECs were addicted to reciprocal compensation, ILECs are addicted to special access and rural carriers are addicted to universal service and access fees. So far, [CLECs] are the only ones that have gone through forced rehab. Now, it's everyone else's turn.”

Most rural representatives have indicated they do not plan to let the current universal-service system expire without a fight, but Alltel President and CEO Scott Ford encouraged other rural carriers at Telecom '04 to be open-minded about rules that will give them a way to make a transition to an IP-based environment.

“If all we do is resist, the [universal-service] system will snap,” Ford said.

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