Before the Federal Communications Commission Washington, D.C. 20554 FCC 94-199 In the Matter Of ) ) Amendment of Part 36 of The ) CC Docket No. 80-286 Commission's Rules And ) Establishment of a Joint Board ) NOTICE OF INQUIRY Adopted: August 2, 1994; Released: August 30, 1994. By the Commission: Comment Date: Friday, October 28, 1994. Reply Comment Date: Friday, December 2, 1994. TABLE OF CONTENTS Paragraphs I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . .1 - 2 II. BACKGROUND OF HIGH-COST ASSISTANCE . . . . . . . . . 3 - 8 III. GENERAL ISSUES RELATING TO HIGH-COST ASSISTANCE . . . 9 - 17 IV. ALTERNATIVES FOR REVISING HIGH-COST ASSISTANCE . . . 18 - 86 A. Determining and Controlling the Total Amount of High-Cost Assistance . . . . . . . . . . . . . . .18 - 25 B. High-Cost Assistance Based Upon Actual Costs . . . 26 - 56 1. Defining the Costs Used To Determine Assistance . . . . . . . . . . . 27 - 33 2. Modifying the Current High-Cost Assistance Mechanisms . . . . . . . . . . . . . . . . . 34 - 58 a. Reevaluate Assistance to Large LECs Or Non-Rural Areas. . . . . . . . . . . 35 - 44 b. Establish a Sliding Scale Of Assistance . . . . . . . . . . . . . 45 - 48 c. Reevaluate the Percentage of Assistance for Above-Average Costs. . . 49 - 50 d. Change the Threshold For USF Assistance . . . . . . . . . . .51 - 56 e. Reevaluate DEM Weighting . . . . . . . .57 - 58 C. High-Cost Assistance Based Upon Proxy Factors . . 59 - 71 1. Determine USF Assistance Using A Formula Similar to NECA's Methodology for Determining USF Assistance to Average Schedule LECs . . . . . . . .65 2. Determine USF Assistance Using LEC Study Area Size and Population Density as Proxy Factors . . . . . . . . . . 66 - 68 3. Combine a Proxy Factor for Cost And a Proxy Factor for General Need In Determining Assistance . . . . . . . . . .69 - 71 D. Use Proxy Factors to Make an Initial Determination of the Amount of High-Cost Assistance to be Directed to Each State Jurisdiction . . . . . . . . . . . . . 72 - 77 E. Establish a Voucher or Credit System For Telecommunications Users . . . . . . . . . . . 78 - 80 F. Need for Transition Mechanisms . . . . . . . . . .81 - 82 V. PROCEDURAL MATTERS . . . . . . . . . . . . . . . . . .83 - 86 A. Ex Parte . . . . . . . . . . . . . . . . . . . . . . . .83 B. Regulatory Flexibility . . . . . . . . . . . . . . . . .84 C. Comment Dates . . . . . . . . . . . . . . . . . . .85 - 86 VI. ORDERING CLAUSE. . . . . . . . . . . . . . . . . . . . . . 87 APPENDIX: HISTORY OF THE UNIVERSAL SERVICE FUND AND DEM WEIGHTING I. The Universal Service Fund . . . . . . . . . 1 - 7 II. DEM Weighting . . . . . . . . . . . . . . . . 8 - 11 I. INTRODUCTION 1. In this Notice of Inquiry (Notice), we seek to develop information concerning the manner in which our Part 36 jurisdictional separations rules are used to provide interstate assistance to local exchange carriers ("LECs"). Currently, LEC study areas with greater than average costs per loop receive high- cost assistance from the Universal Service Fund ("USF"). In addition, study areas with fewer than 50,000 loops receive interstate assistance for their local switching costs through the application of a multiplier to their interstate usage of local switching equipment. 2. The Notice invites comment on various policy questions relating to the provision of high-cost assistance. It also seeks comment on the goals of high-cost assistance, and on whether high-cost assistance should be used to promote facilities modernization, in addition to supporting nationwide availability of telephone service at affordable rates. We ask commenters to address the appropriate level and targeting of high-cost assistance and to evaluate the relationship between high-cost assistance and the development of competition in local services. We also request comment upon a number of alternatives for changing the present high-cost assistance mechanisms. These alternatives would take two primary approaches: the first is based upon individual reported costs, as are the present USF rules; and the second is based upon factors designed to reflect general cost characteristics and economic conditions. Finally, we invite comment upon the need for a transition mechanism in the event we modify or replace the existing high-cost assistance rules. II. BACKGROUND OF HIGH-COST ASSISTANCE 3. It has been more than nine years since we originally decided to implement high-cost assistance by adopting our USF rules. Nearly seven years have elapsed since we adopted the DEM weighting assistance program for small study areas in order to ameliorate potential jurisdictional cost shifts associated with changes in the classification of local switching equipment. Last year, the gradual phase-in of the USF and DEM weighting was completed. We believe that it is appropriate at this time to consider how well the USF and DEM weighting subsidy programs have achieved their objectives and to evaluate whether changes, large or small, would make these programs more effective. Reevaluation of our high-cost assistance rules should not, however, be limited to fine-tuning or review of past performance. The need to consider changes to high-cost assistance mechanisms is broad-based and fundamental. 4. The USF was first adopted by this Commission in 1984 in conjunction with the establishment of fixed percentage basic allocation factors for jurisdictional separation of non-traffic- sensitive ("NTS") costs. The USF was intended to promote universally available telephone service at affordable rates. Before the USF rules were implemented, we modified the USF structure, adopting a two-tiered system of assistance which increased support for small LECs and decreased assistance to larger LECs. Three years later, we readjusted the USF by further increasing assistance to small LECs and decreasing assistance to large LECs. The USF and the basic allocation factors were phased in during a seven-year transition period, beginning in 1986 and concluding in 1993. 5. Since our initial adoption of the USF in 1984, changes in technological capabilities and costs, market structure, and regulatory options have revolutionized the telecommunications marketplace. At this point in time, the conversion to equal access is virtually complete, interexchange competition is increasingly robust, cellular services are widely available, fiber optic facilities have been deployed extensively for both nationwide backbone networks and local access purposes, and other technologies and services, such as cable television and personal communications service, may, in the near future, offer services that are functionally equivalent to today's switched telephone service. We also note the efforts of many private companies to extend the reach of their networks by taking steps to include the connection of classrooms, libraries, and healthcare facilities to the telecommunications infrastructure as part of their investment planning. In addition, new forms of regulation, including incentive-based approaches such as price caps, have been adopted in numerous jurisdictions. 6. We recognize that as technologies change, it may be necessary in the future for the Commission to undertake a comprehensive review of our universal service goals. At this time, in light of the numerous changes in the telecommunications industry since our initial adoption of the USF, we believe it is incumbent upon us to chart a course for high-cost assistance that acknowledges the state of today's telecommunications industry and makes provision for tomorrow's developments. We now have several years of experience with USF high-cost assistance. The availability of historical data should facilitate productive evaluation of the existing mechanisms. We expect to use this information to assess the effectiveness of the current USF rules, in light of the present and future goals of high-cost assistance. We also intend to consider issues related to the total amount of high-cost assistance, as well as the rate and pattern of growth in the amount of assistance. For these reasons, it is appropriate at this time to review and to evaluate the targeting and overall growth of the USF as currently structured, and to obtain comment on possible revisions. 7. Similarly, the time is ripe for us to examine the purposes and effects of DEM weighting assistance. When first adopted in 1987, DEM weighting was intended to ameliorate the potential adverse effect on some small LECs of eliminating the NTS allocation previously used in the jurisdictional separation of local switching equipment. In recent years, however, DEM weighting has appeared to give an incentive to some LECs to manipulate our separations rules as they categorize their costs associated with certain types of equipment. Now, at the conclusion of the transition period for phasing in DEM weighting, we seek information on a number of issues related to this form of assistance. Among those issues are questions relating to the total amount of assistance provided through DEM weighting, the necessity of continuing DEM weighting on a permanent basis, the targeting of DEM weighting, and the possibility of restructuring the DEM weighting assistance mechanism or combining it with the USF assistance program. 8. This Notice seeks information on two principal approaches to revising our high-cost assistance mechanisms. The first approach, which would continue to base high-cost support upon recipients' reported costs, would entail a number of possible modifications to the existing USF and DEM weighting rules. The second approach would replace the current cost-based USF assistance mechanisms with a system providing high-cost assistance based upon one or more factors that would serve as a proxy for reasonable costs. The use of proxy factors would create a direct incentive for recipients to reduce their cost of providing service, unlike the current USF mechanisms, that base the assistance provided to service providers upon their reported costs. We ask that interested parties consider both the individual alternatives presented in this Notice as well as the possibility of combining various alternatives to produce an optimal system of high-cost assistance. III. General Issues Relating to High-Cost Assistance 9. In this Notice, we request comment on a number of measures for revising the high-cost assistance mechanisms contained in our rules. These alternatives span a broad spectrum, ranging from modification of the existing rules to implementation of an entirely new system of high-cost assistance. We request interested parties to comment upon the various alternatives in light of the broader issues discussed below. 10. High-cost assistance quite obviously must serve the goals underlying the principle of universal service. For example, high-cost assistance can play a role in preserving and enhancing universal telecommunications services and just and reasonable rates. In furtherance of the goal of universal service, however, the high-cost mechanisms ultimately adopted should reflect the most efficient use of resources to promote universal service, so that they do not inadvertently impose excessive burdens on either users or services that provide assistance. We believe that an efficient system of high-cost assistance should display three primary characteristics. 11. First, assistance should be tailored so that only those users or service providers who need assistance to ensure universal service receive support. We ask the commenters to focus carefully on the targeting structure and effect of the various alternatives for revision of our high-cost assistance mechanisms. 12. Second, an optimal high-cost assistance mechanism should promote efficient investment and operation. Incentives to engage in "goldplating," or to invest in certain types of facilities when other facilities would be more economically efficient, should be eliminated or minimized, if it is possible to do so without significant harm to other public policy goals. Similarly, the high-cost assistance mechanisms should not create artificial incentives for carriers to sell or acquire facilities. We invite the commenters to discuss the extent to which the various alternatives display this quality. 13. Third, the best high-cost assistance mechanism would not impose excessive subsidy costs upon interstate carriers and ratepayers. An efficient and properly structured system of high- cost assistance should make it possible to minimize the cost of assistance while still providing adequate support to its recipients. Thus, the overall amount of assistance should reflect a balancing of universal service goals with our desire to avoid placing an unreasonable burden upon interstate telecommunication. We remain confident that an efficiently targeted system of high- cost assistance can serve all of those goals. 14. Before describing specific alternatives for revising our USF and DEM weighting rules, we must examine the goals to be served by our high-cost assistance programs. The pertinent Joint Board recommendations as well as our orders are replete with references to the intention that the USF promote affordable local rates, lower than the rates would be absent high-cost support. Implicit in the goal of high-cost assistance was the notion that "universal service would be threatened by rate increases of a magnitude sufficient to cause a significant number of subscribers to cancel service." We believe that it is important to reconsider the purpose of high-cost assistance as part of our evaluation of the existing USF and DEM weighting rules and our consideration of possible replacement or refinement of those mechanisms. We therefore request that interested parties comment upon whether high-cost assistance should be extended to support facilities modernization in addition to affordable local rate levels. We also ask whether high-cost assistance should be targeted to support basic services without providing assistance for more advanced service offerings. 15. We also seek comment on the appropriate balance to strike between promoting the need for high-cost assistance and the need to avoid imposing unreasonable burdens directly upon interexchange carriers or other telecommunications service providers and indirectly upon their subscribers. We believe that it is crucial to target assistance in the most effective and efficient manner possible, in order to avoid imposing unnecessary costs that would cause large increases in the total subsidy level. We seek proposals for accomplishing such targeting. In a separate section of this Notice, we request comment regarding customer vouchers that would target high-cost assistance to individual telecommunications users, similar to the current lifeline and link- up programs. Such an assistance structure could allow us to target assistance more precisely and to eliminate barriers to competitive entry that may be inherent in a system that provides assistance only to the established carriers. 16. High-cost assistance also could significantly affect the development and viability of competition in local telecommunications services. The existing USF and DEM weighting mechanisms, which give high-cost assistance only to LECs, may serve as barriers to entry by competing service providers. We ask parties to identify what measures, if any, might be taken to ensure that our high-cost assistance mechanisms do not act as de facto barriers to entry by giving existing LECs insurmountable cost advantages over potential competitors. Conversely, it is possible that the LECs' status as providers of last resort for basic telephone service gives potential competitors that do not share this obligation a cost advantage over LECs that serve both high cost and low cost areas. 17. Finally, we request parties to propose means by which we can ensure that high-cost assistance is used by recipients to offer their subscribers lower local telephone rates. High-cost assistance should not be used by recipients to increase their rates of return to excessive levels rather than to reduce their charges to local subscribers. We seek comment on ways to deter this and any other unintended and undesirable results. In addition, if we determine that high-cost assistance should be targeted to support specific services, we ask for comment on whether and how we could deter recipients from using high-cost assistance to subsidize other services. In particular, we request parties to comment upon the need to include attestation requirements or periodic audits as part of our high-cost assistance program. We also invite comment regarding the desirability of reporting requirements for assistance recipients' uses of fund revenues, local rate levels, and earned rates of return. Finally, we solicit proposals for implementing any or all of these requirements in a manner that would not be unduly burdensome to recipients. IV. ALTERNATIVES FOR REVISING HIGH-COST ASSISTANCE A. Determining and Controlling the Total Amount of High-Cost Assistance 18. In our recent Interim Notice, we expressed our concern over the relatively rapid growth of the USF during the past several years. Since its inception, the full-transition amount of the USF has grown nearly sixty percent, or almost seven percent per year. As we indicated, we believe that the time has arrived to determine whether USF growth of this magnitude is essential to promote universal service. 19. At present, the USF exceeds $700 million annually and DEM weighting, intended to benefit small LECs, adds another $300 million of annual assistance. We seek proposals for retargeting assistance to reduce the overall level of support while ensuring adequate support for those LECs or LEC customers genuinely in need of assistance. In addition, we request that commenters addressing the specific alternatives described below include in their comments an estimate of the total amount of high-cost assistance necessary to maintain universal service. Finally, we ask the commenters to compare the efficiency of the various alternatives for high-cost assistance, and to identify the measure or measures that would promote universal service while imposing the least costs upon interstate carriers and ratepayers. 20. After reviewing the record compiled in response to this Notice, we intend to propose specific revisions to our high- cost assistance mechanism that will allow us to reduce subsidy costs borne by interstate ratepayers while ensuring that universal service is not jeopardized in areas that require support. Because the USF is funded through interstate tariff charges paid by IXCs, increases in the USF may require IXCs to raise the interstate toll rates paid by telecommunications users. Such increases would depress demand for these interstate services. The implications for the telecommunications industry, and consequently for the general economy, are significant. For these reasons, the structure and magnitude of high-cost assistance are matters of considerable concern to this Commission. 21. In our recent Interim Order, we adopted interim rules employing an index factor to moderate growth in the USF pending adoption of final rules. As we noted in the Interim Order, growth in the USF has been erratic during the years that the fund has been in existence. That pattern of growth triggers questions regarding its cause, including the question of whether past growth reflected actual need for increased USF support or, instead, was a result of unanticipated defects in the structure of our assistance mechanisms. In the future, we wish to avoid, to the extent possible, unjustified surges in the level of assistance provided to high-cost LECs and collected from interstate carriers and ratepayers. 22. We request comment upon the utility and advisability of adopting a permanent indexed cap on high-cost assistance. A cap would prevent sudden, large increases in the level of high-cost assistance. At the same time, we believe that the amount of high- cost assistance should be allowed to grow moderately over time if needed to promote universal service effectively. Accordingly, we do not intend to propose freezing the level of assistance but, instead, seek comment evaluating the merits of various potential indexing factors. 23. In our Interim Order, we temporarily indexed growth in the capped USF to the percentage of growth in the total number of access lines nationwide. As we indicated, that rate of growth has been relatively stable and moderate over the past few years. If the level of high-cost assistance were permanently indexed to the rate of growth in total access lines, it appears that a steady, stable, and moderate rate of growth in high-cost assistance would be likely. Accordingly, we seek comment on the use of the rate of growth in total access lines as a longer-term index factor for growth in high-cost assistance. 24. We also seek comment on indexing growth in total high-cost assistance to an inflation-based factor. Our decision, earlier in these proceedings, not to freeze the total level of the USF was based upon the Joint Board's belief that a total freeze "would effectively decrease the amount of assistance over time due to inflation." If total high-cost assistance were indexed to an inflation-based factor, similar to the operation of price caps, we could avoid the problem anticipated by the Joint Board. 25. Finally, we also invite commenting parties to propose other index factors that may ensure moderate growth in the level of high-cost assistance. We ask that commenters evaluate proposed index factors in terms of their verifiability, susceptibility to manipulation, stability over time, ability to ensure adequate support for universal service, and potential effect upon the annual rate of growth in total high-cost assistance. B. High-Cost Assistance Based Upon Actual Costs 26. Our current LEC assistance mechanisms are based upon the actual reported costs of LECs. As we discuss in Section IV.C. of this Notice, this use of actual reported costs does not provide a direct incentive for carriers to reduce or minimize their costs, and for that reason we invite comment on the use of various proxy factor approaches to replace the current assistance mechanisms. While the proxy approach appears promising, it may be difficult to identify proxy factors that correlate sufficiently with high-cost operations. In addition, even assuming that reliable proxy factors can be identified, many high-cost service providers may not fit the high-cost profile derived from the proxy factors. For these reasons, we are unwilling to dismiss the use of actual costs without further evaluation. We therefore request comment regarding several alternatives for revising the current assistance rules based upon reported costs. 1. Defining the Costs Used to Determine Assistance 27. Under our current LEC support mechanisms, loop costs and switching costs form the respective bases for USF and DEM weighting assistance. The USF provides high-cost assistance to both large and small LECs whose loop costs exceed the nationwide average by prescribed percentages. DEM weighting, based upon switching costs, provides interstate assistance to all small LECs, regardless of the level of their costs. The different structures of these two assistance mechanisms has provided an incentive for some LECs to miscategorize the costs associated with certain types of facilities. If the two assistance mechanisms were combined into one program applying a single standard for support, the existing incentive for miscategorization of costs could be removed. We therefore request comment upon the appropriateness and practicability of combining loop costs with switching costs to determine the amount of assistance to be provided to a high-cost carrier. 28. One potential problem with combining loop and switching costs to determine high-cost support is that a substantial portion of many LECs' switching costs is associated with the provision of toll service rather than local exchange services. Because high-cost assistance was intended to provide support for local services, it would be ideal to base support on costs related solely to the provision of local services. Including toll switching costs in the basis for a LEC's high-cost assistance may be inconsistent with the original goals of high-cost assistance. 29. In addition, basing high-cost assistance upon the combination of loop and switching costs may not be fair to some high-cost carriers. We currently base USF support on a company's total unseparated loop costs compared to the national average for such costs. If we retain that general structure for assistance but base support on a combination of loop and switching costs, carriers with a lower than average proportion of toll traffic may be disadvantaged. This could occur because the total cost per subscriber line for switching can vary significantly depending on the extent of a carrier's toll traffic operations. LECs that provide a large volume of toll service are likely to have very high unseparated switching costs. Those LECs' total loop and switching costs per subscriber line thus are likely to be significantly greater than carriers that handle primarily local exchange traffic, and carriers with less toll investment per subscriber line thus could lose high-cost assistance, despite having extremely high costs associated with the provision of local service. 30. Because high toll costs are not related to the provision of local service, we question whether they should be the subject of high-cost assistance. Therefore, we invite comment on whether we should exclude all, or a portion of, toll switching costs from any high-cost assistance mechanism that combines loop costs and switching costs. In raising this issue, we recognize that there is no established procedure for allocating switching costs between toll related services and other services. We believe that intrastate costs, especially if adjusted to remove toll switching costs as discussed above, may be a reasonable surrogate for "local" costs. We invite comment on whether we should prescribe a method for allocating between those two types of services and, if so, what method we might prescribe. We also invite comment on the criteria we might use to determine which toll switching costs should be excluded from high-cost assistance calculations in the event we decide that a portion of those costs should be excluded. 31. We are also concerned that it may be difficult to identify all costs associated with "local" traffic. For example, local traffic moves between central offices and accesses the public switched network by exchange trunks, and host remote trunks carry local traffic between remote switches and central offices. The costs associated with these local trunks would not, however, be classified as "local" costs using the existing Part 36 categories. Accordingly, we request comment on whether the costs of exchange trunks and host remote trunks should also be included in the definition of "local" costs. 32. We ask interested parties to propose a definition of eligible costs that is fair and practicable to administer. We ask, in particular, whether the increased complexity of a methodology that excludes toll switching costs while including all identifiable local service costs would be justified by its benefits. 33. Finally, we wish to consider the exclusion of certain types of costs from the data used to calculate the amount of a carrier's high-cost assistance. Specifically, we invite comment on whether we should remove general support expenses, executive and planning expenses, and general and administrative expenses from the basis for high-cost assistance. A high level of these costs may chiefly reflect managerial and administrative decisions rather than an inherently high cost of providing telephone service. For that reason, we ask interested parties to address the appropriateness of excluding these costs from the cost basis for receipt of high-cost assistance. 2. Modifying the Current High-Cost Assistance Mechanisms 34. In this Notice, we invite comment on a number of alternative high-cost assistance mechanisms. Some of those alternatives would markedly depart from the structure of our existing rules. We are, however, also interested in considering modifications to the existing support mechanisms, in light of several years of experience with the current rules, to target more effectively the highest cost LECs that are in greatest need of assistance. a. Reevaluate Assistance to Large LECs or Non-Rural Areas. 35. Throughout this proceeding, we and the Joint Board have repeatedly determined that small telephone companies, particularly those serving rural areas, have greater need of high- cost assistance than the larger LECs. In fact, we have twice retargeted the USF by decreasing assistance to large study areas. In its 1987 Retargeting Recommendation, the Joint Board noted the projections of four LEC trade associations that the retargeting measures recommended by the Joint Board would "increase from 53% to 83% the proportionate share of high cost fund assistance paid to LECs with less than 200,000 lines." 36. Setting 200,000 loops as the outer limit for "small" study areas has, however, still directed a sizable portion of the USF toward several of the largest LEC holding companies. In 1993, study areas owned by six of the eight largest LEC holding companies received approximately $290 million in USF assistance - - more than forty percent of the total USF. Although the amount of the large LECs' assistance per loop per month is generally small, the large number of loops owned by those carriers results in significant payments. 37. If the goals of high-cost assistance were expanded to include support for facilities modernization, massive growth in the fund could result unless the high-cost support mechanisms are retargeted. Specifically, such retargeting is likely to focus assistance more narrowly upon the users and service providers with the greatest need for support. Previously in this proceeding, it has been proposed that "at some point the high cost fund should be modified to eliminate support for the high cost study areas of the large LECs." In this Notice, we ask interested parties to comment upon the extent to which high-cost assistance to the largest LECs or to non-rural areas is essential to promote universal service, and to address measures that would focus assistance more narrowly upon small study areas and rural regions. 38. Eliminate or Revise High-Cost Assistance to LECs Serving Large Study Areas. We invite interested parties to discuss whether it would be practicable to reduce or eliminate high-cost assistance to certain categories of service providers or service areas without imperiling our universal service goals. Specifically, we request comment upon the elimination of high-cost assistance for large study areas, which generally are owned by the largest LEC holding companies. These are financially healthy enterprises whose resources dwarf those of most of the other recipient companies. The USF is a system of general assistance determined by an assessment of each LEC's need for support throughout each of its study areas. The current system assumes that study areas served by small LECs have a greater proportionate need for high-cost assistance than study areas served by large LECs. As the Joint Board concluded earlier in this proceeding, larger LECs (and larger study areas) appear to have more flexibility than small companies in dealing with above-average costs. We are, however, concerned that limiting high-cost assistance to small LECs or small study areas might reduce the large LECs' incentives to modernize, or even to continue to operate, high-cost exchanges. We are also concerned that the elimination of assistance for larger LECs could limit their ability to respond as competition develops in their local service areas. 39. We seek comment on eliminating assistance to large study areas. In addition, we request specific comment regarding the appropriate number of loops to use in defining eligibility for high-cost assistance in the event we take that step. One possibility would be to use 200,000 loops, already a distinguishing standard in our USF rules, as the cut-off point for assistance. We note, however, the Joint Board's opinion, in setting the standards for DEM weighting, that "a carrier with 50,000 to 200,000 loops does not qualify as a small carrier." We therefore request that interested parties comment upon setting the limit at 50,000 or 100,000 loops. 40. If assistance to large study areas were to be eliminated, we ask commenters to propose an appropriate cut-off point if a sliding scale of assistance is adopted, as discussed in subsection IV.B.2.b., infra. If we adopt a sliding scale, it may be necessary to raise slightly the number of loops used as the cut- off point for assistance, in order to ensure that the percentage of assistance does not decline too rapidly for small LECs. Nonetheless, we believe that raising the cut-off point too high might defeat the purpose of eliminating high-cost assistance to large study areas. We seek comment on this analysis. 41. A variation on eliminating assistance to large study areas would be to eliminate high-cost assistance to price cap LECs. One rationale for such a delineation is that these carriers, like large study areas, are generally subsidiaries of large LEC holding companies with substantial resources or that may be able to maintain rates in high-cost areas at reasonable levels through internal subsidy mechanisms. In addition, this approach appears consistent with a price cap system of incentive regulation which encourages LECs to reduce costs. On the other hand, limiting high- cost assistance to non-price cap carriers could have the undesirable effect of discouraging LECs from electing price cap regulatory treatment. Moreover, this approach could exacerbate any existing incentives for price cap LECs to cease to operate high- cost exchanges. We request comment on this approach and, in addition, we invite interested parties to propose an effective means of eliminating or reducing support to LECs serving large study areas. 42. Eliminate Assistance to Non-Rural Areas. When we first implemented USF assistance, we expressed concern that reasonably-priced local service remain available in rural areas, which frequently have higher costs than more populous service areas. Instead of targeting assistance to rural areas, however, we adopted a system that compares average costs within each study area to the nationwide average, and then allots assistance on the basis of loops. One consequence of this approach is that a large portion of current USF assistance is provided to study areas composed of both rural and non-rural areas. 43. In reply comments submitted in response to our Interim Notice, US West proposed that USF assistance be retargeted so that it is available only in those exchanges where the preservation and expansion of universal service is in real jeopardy. US West argues that universal service is not a concern in urban and suburban areas but that companies serving those areas can, under the current rules, receive USF assistance to fund advanced facilities deployment, such as fiber to the curb. US West also contends that competitive entry has occurred, or will soon begin, in urban and suburban telecommunications markets, and that providing USF assistance to only one participant--the LEC--is not conducive to further competitive development. 44. We request comment on whether we should target high- cost assistance only to rural areas where the cost of service is frequently high and where competitive entry may be less likely in the near future. One of the proposals suggested by US West in its reply comments is to target high-cost assistance to loops outside Metropolitan Statistical Areas ("MSAs"). We invite interested parties to comment on that approach, as well as a modified version, which would eliminate high-cost assistance to recipients within MSAs that exceed a specific population level. The modified version would allow some support for non-rural areas but would not assist the most densely populated areas where lower costs and competitive entry are likely. Commenters should address the effectiveness of these methods in targeting geographic areas most in need of high- cost assistance and the practicability of an MSA-based approach. In addition, commenters supporting the modified version should propose an upper population limit beyond which an MSA would not be eligible for assistance. b. Establish a Sliding Scale of Declining Assistance. 45. As we have already noted, under our current USF rules study areas with fewer than 200,000 loops may allocate a greater percentage of their qualifying loop costs to the USF than those study areas with more than 200,000 loops. This sharp line of demarcation has drawn a significant amount of criticism. Critics have charged that our rules could cause study areas of similar size to receive radically different payments from the USF. For example, under our current rules, for a study area with an average loop cost that is 145 percent of the nationwide average, the USF assistance factor would be 65 percent if the study area had 199,000 loops but would be only 10 percent if the study area had 201,000 loops. 46. In addition, our existing high-cost assistance rules for study areas with 200,000 or fewer loops may undermine those carriers' incentives to invest and operate efficiently. Those small carriers currently allocate 90 to 100 percent of their incremental loop costs (above the threshold for assistance) to the interstate jurisdiction. While a number of the smallest, highest cost LECs may require that degree of assistance, affording these levels of interstate allocation to all high-cost study areas with 200,000 or fewer loops provides no incentive to avoid or reduce excessive costs. A sliding scale of assistance could remedy that problem in an equitable manner, by maintaining the smallest, highest cost study areas near their current percentage of high-cost assistance and gradually decreasing the percentage of assistance for larger study areas. 47. In the preceding section, we have invited comment on eliminating assistance to study areas having more than a specified number of loops. We believe that our high-cost assistance mechanisms might function more smoothly and fairly if the different treatment of study areas based on number of loops were accomplished gradually. For that reason, we also invite comment on the desirability of a sliding scale of assistance, whereby the smallest carriers have the highest USF allocation factor, with that factor declining gradually based on the size of the study area. The sliding scale would provide high-cost assistance at some maximum percentage factor for the smallest study area and would decline on a linear basis to zero assistance at the cut-off point for study area size (based on the number of loops). 48. We seek comment on the appropriate number of loops per study area to use as a cut-off point for receipt of high-cost assistance. We specifically ask parties to address the use of 200,000 loops, the current point of differentiation between large and small study areas, as the point at which assistance is eliminated. We also request comment regarding other cut-off points, both less than or greater than 200,000 loops. Finally, we ask interested parties to propose an appropriate percentage for the maximum high-cost assistance factor to be used for the recipients with the fewest loops. c. Reevaluate the Percentage of Assistance for Above- Average Costs. 49. Assuming that we do not adopt a sliding scale, as we suggested in the preceding section, we request comment upon changing the percentage of interstate assistance for carriers with average loop costs above the threshold for assistance. Under the current USF assistance rules, LEC study areas with fewer than 200,000 lines may allocate 65 or 75 percent of their high costs (i.e., loop costs above the threshold for assistance) to the interstate jurisdiction. With the basic interstate allocation of 25 percent, those recipients are able to allocate 90 or 100 percent of their incremental loop costs to the interstate jurisdiction. 50. We are concerned that LECs allocating a high percentage of their incremental loop investment to interstate operations may have little incentive to avoid costs that are not justified by sufficient customer demand or other economic need. While it is important to provide high-cost support sufficient to maintain the nationwide availability of reasonably priced local telecommunications service, support levels that are too high may provide no incentive for efficient investment and operation. We therefore request interested parties to comment upon whether the current high-cost factors have stimulated such financial practices by recipients of assistance and, if so, whether the high-cost factors should be reduced for some or all recipients. d. Change the Threshold for USF Assistance. 51. Since initial implementation of the USF in 1986, the number of USF assistance recipients has grown dramatically. Even more significant, LECs are receiving USF assistance for an increasing percentage of loops and study areas as well. When USF support began in 1986, USF recipients received assistance on the basis of 19.5 million loops, approximately 18 percent of all loops. By 1993, LECs were receiving USF assistance for 36.5 million loops, or nearly 27 percent of the nationwide total number of loops. Similarly, the percentage of study areas receiving USF assistance has grown from 66 percent in 1986 to 78 percent in 1993. This expansion in the base of USF recipients has, correspondingly, increased the total amount of USF support. 52. We believe that high-cost support should be targeted toward those companies, and their subscribers, that are in significant need of assistance in order to fulfill our universal service goals. We also believe that USF assistance should not be a routine source of revenue for a large majority of LEC study areas. Moreover, the large percentage of LEC study areas receiving assistance tends to undermine our 1984 decision to adopt a basic allocation factor for jurisdictional separation of NTS costs. We believe that further expansion in the base of USF recipients could be limited by adjusting the threshold for qualifying to receive USF assistance. We therefore request comment regarding two alternatives for adjusting the threshold for assistance. We also request comment on the general issue of whether permitting an expanding base of USF recipients is in the public interest. We ask that commenting parties address the appropriate percentage of loops and study areas to receive USF assistance. 53. Raise the Threshold for Receiving High-Cost Assistance. At present, for a LEC study area to receive USF support, its average loop cost must be at least 115 percent of the nationwide average loop cost per working loop. The current threshold, which allows nearly 80 percent of all study areas to receive some level of assistance, may be lower than is necessary to meet our universal service goals. Moreover, the costs per loop of many large carriers are close to the threshold. Thus, although the amount of assistance per loop directed to those carriers may be relatively small, the total amount of assistance provided to them is large due to the large number of loops within their study areas. 54. If the basic structure of the current USF high-cost assistance mechanism is retained, we could raise the threshold for receiving high-cost assistance perhaps to 130 percent. Raising the threshold would maintain support for extremely high-cost carriers most in need of assistance, while eliminating assistance to carriers with costs relatively close to the national average. Moreover, if the Commission were to expand the goals of high-cost assistance, this adjustment could still make support available for modernization and technological improvements in the highest cost areas without significantly raising the total amount of assistance. We ask for comment upon this approach. 55. Adjust the Threshold to Reflect Relative Deviation from the Nationwide Average. Rather than simply raising the qualifying threshold to some fixed amount, we could, instead, develop a threshold based on accepted statistical methods that would be adjusted as the dispersion characteristics of LECs' costs per loop change relative to the national average. One such possibility is to set the qualifying threshold for USF assistance at the national average cost per loop plus one "standard deviation" or some fraction of one standard deviation of LEC costs per loop. 56. Setting the threshold for assistance on the basis of standard deviation from the mean would directly address changes in the dispersion characteristics of LEC costs per loop. Adjustment of the threshold using this method thus could prevent or mitigate continuing expansion in the percentage of loops or study areas receiving assistance. For the same reason, this method would likely moderate growth in total high-cost assistance while continuing to support the highest cost LECs. LECs with very high costs per loop would be affected only slightly, and only those LECs whose costs per loop are close to the current threshold would experience a significant change in the level of assistance received. We ask for comment on this method of establishing the annual threshold for USF assistance. e. Reevaluate DEM Weighting. 57. In Section IV.B.1. of this Notice, we invite comment on including switching costs within the costs that form the basis for high-cost assistance. If this approach were adopted, it could replace the current DEM weighting assistance mechanism for small LECs. We invite comment upon the advantages and disadvantages of combining the current USF and DEM weighting assistance programs into a single form of high-cost support. 58. We also ask commenters to discuss whether we need to continue DEM weighting, even in the event that USF assistance continues to be based solely upon loop costs. Specifically, we ask that interested parties address the question of whether high-cost study areas typically experience much higher than average switching costs as well as loop costs. If that is not the case, we request comment upon whether DEM weighting assistance should be eliminated or revised, and what effects, if any, could be expected to follow from such changes. C. High-Cost Assistance Based Upon Proxy Factors 59. High-cost assistance mechanisms based upon actual costs do not encourage cost reduction or minimization, because they allow recipients to obtain additional assistance when they incur additional costs. Under the current USF rules, as discussed in Section IV.B.2.c., recipient LEC study areas with 200,000 or fewer lines currently allocate 90 to 100 percent of their above-threshold incremental loop costs to the interstate jurisdiction. Because the USF is defined by aggregating the qualifying costs of hundreds of separate recipient study areas, our ability to examine the underlying costs for all of those companies is clearly limited. Consequently, there is a relative lack of accountability in this system of assistance which, because it is based upon actual reported costs, does not discourage unnecessary expenditures. Moreover, because high-cost assistance is based on only certain categories of costs, our rules may influence unduly carriers' investment decisions and categorization practices. Finally, a cost-based assistance program that differentiates between large and small study areas could create an artificial incentive for large LECs to cease to operate their high-cost exchanges. 60. As we reexamine the goals of high-cost assistance, the costs associated with new investment cannot be ignored in evaluating the current assistance mechanisms and, if necessary, in designing new methods. It is imperative that investments to improve and enhance the telecommunications infrastructure impose only necessary costs upon all segments of the telecommunications industry. Such efficiency is particularly important with respect to the existing system of high-cost assistance, because the new investments of high-cost assistance recipients will be funded, at least in substantial part, by other telecommunications carriers and their subscribers. Imposing excessive costs on other segments of the industry could inflate unnecessarily rates for those services. Accordingly, we believe that it is important to examine alternative bases for assistance that would encourage support recipients to control their costs of providing service, thereby minimizing the costs imposed upon other telecommunications users. 61. Consistent with our goal of properly targeting assistance to high-cost companies while promoting efficient investment and operation, we wish to examine alternatives that would base assistance on the application of relevant proxy factors. In essence, this approach would determine each recipient's assistance on the basis of the reasonable costs per loop for carriers with certain characteristics, rather than on the basis of the recipient's actual reported costs. A recipient's amount of high-cost assistance thus would reflect the difference between its projected reasonable cost per loop, as established by the proxy factors, and the nationwide average cost per loop. Basing a recipient's assistance on the projected reasonable cost to serve high-cost areas could replace the current rewards for excessive costs with an incentive for recipients to curb costs. In addition, if properly structured, a proxy approach would have the advantage of calculating assistance based upon readily available and verifiable information. 62. At earlier stages of this proceeding, we raised the issue of using proxy or surrogate factors to apportion USF assistance. Although we have declined in the past to use cost surrogate factors, we believe that the time has arrived to explore this alternative in greater depth. A properly designed proxy approach could promote infrastructure development and ensure adequate support for high-cost areas while deterring inefficient expenditures. 63. A reasonable method for calculating assistance on the basis of proxy factors should rely on a limited number of relevant and readily verifiable factors. Many characteristics previously proposed as proxy factors appear either too difficult to verify, insufficiently correlated with high costs, or both. For example, a system that attempted to classify and assign weight to various types of terrain based upon the projected cost of providing service would be extremely difficult to design and verify. Local rate levels, for a variety of reasons, may not correlate adequately with high cost of service and could raise complex issues relating to the size and definition of local calling areas. Using average length of loop or subscriber density per loop mile might not be sufficiently susceptible to verification, even if it could be demonstrated that either or both of those factors correlate significantly with cost of service information. We therefore do not at this time set forth a specific proxy methodology that incorporates any of the foregoing factors. Nonetheless, we request comment on whether and, if so, how those factors might be included in a proxy methodology. 64. The proxy methodologies on which we now invite comment involve the use of factors that demonstrate reasonable correlation with cost levels or the need for high-cost assistance. In addition, the factors appear easier to verify than most other potential proxy factors. We seek comment on the proxy methods described below. In addition, we request comment upon the suitability of a proxy approach for accomplishing our universal service goals. Finally, we ask that commenting parties propose additional alternatives for appropriate proxy methodologies. 1. Determine USF Assistance Using a Formula Similar to NECA's Methodology for Determining USF Assistance to Average Schedule LECs. 65. LECs whose costs are recovered based on average schedule rates currently receive USF assistance based on a formula whose only independent variable is the number of loops per exchange. This formula is developed annually by NECA and is derived from data provided by the cost-based LECs. This type of formula essentially uses exchange size as a proxy factor for cost per loop. Applying such a formula to all LECs would provide assistance based upon the average cost per loop for LECs with similar average exchange sizes. Because recipients would not receive a fixed percentage of assistance for every dollar spent, they would not be rewarded for incurring additional costs. The formula thus would introduce an incentive for cost control that does not exist under the current USF rules. We seek comment on this approach. 2. Determine USF Assistance Using LEC Study Area Size and Population Density as Proxy Factors. 66. Throughout this proceeding, the Joint Board and this Commission have consistently found that LEC study areas with a relatively small number of loops, particularly in rural areas, have greater need for high-cost assistance than larger LECs. Therefore, we invite comment on whether we should take study area size and general population density into account in determining USF assistance. Both study area size and population density may be verified from objective sources. In addition, we believe that population density would display a reasonable degree of correlation with high loop costs. 67. This methodology would involve projecting expected cost per loop on the basis of study area size (i.e., number of loops) and population density. We seek comment on whether using the number of loops as one factor in projecting expected cost per loop would reflect the additional costs associated with small company study areas. Similarly, we seek comment on whether adjusting for the effects of population density would address the special needs of sparsely populated rural areas. 68. This proxy approach, like the first approach, would appear to promote efficiency by abolishing the link between increased expenditures and increased assistance. We seek comment upon this approach for using study area size and population density as proxy factors in establishing the basis for determining USF assistance. We request, in particular, analysis of the extent to which the results under this method could be expected to vary from the results using NECA's current formula for average schedule companies, and the reasons for such variances. In addition, we request proposals for the development of a suitable formula, incorporating these two factors, for calculating high-cost assistance. 3. Combine a Proxy Factor for Cost and a Proxy Factor for General Need In Determining Assistance. 69. One of the original goals of high-cost assistance was to assure that local rates in high-cost areas do not greatly exceed rates in other areas of the country. Nonetheless, variations throughout the country in average income levels and in the cost of living cause corresponding differences in the general affordability of local telephone service. Simply put, the affordability of local telephone service in a given area of the country is likely to be affected by the disposable income of telecommunications consumers in that area. For that reason, the same local rate level may have profoundly different effects upon universal service in different locations, depending on the economic conditions of each area. 70. The third proxy method on which we invite comment would incorporate both a proxy for cost and a proxy for the general economic need of subscribers in a given study area. The proxy factor for cost could include either the elements of the first or second proxy method, as described above. A study area's proxy factor for general need would reflect the average disposable income of individuals within a designated geographic area. Using that approach, areas with extremely low average income levels, or extremely high costs of living, or both, would have a higher proxy factor for general need than areas with average income and cost of living close to the national average. One way of computing disposable income could consist of calculating a ratio of average income to the cost of living. We ask interested parties to comment upon this means of assessing disposable income and to propose alternative methodologies for evaluating average disposable income or other indicia of the general economic need for assistance. 71. We also seek general comment upon this proxy factor method for determining assistance, which would reflect both the expected cost of service and the general economic status of persons living in each recipient study area. In particular, we ask interested parties to comment upon whether the additional complexity of such a system would be justified by greater fairness in the disbursement of high-cost assistance. Finally, we request that interested parties propose a formula containing factors based on the approach to high-cost assistance outlined in this section. D. Use Proxy Factors to Make an Initial Determination of the Amount of High-Cost Assistance To Be Directed to Each State Jurisdiction. 72. We also request comment upon a method that would use, as a first step, a proxy formula to distribute a predetermined amount of assistance among the state jurisdictions. The nationwide total assistance could, if desired, be allowed to grow at an indexed rate. The proxy formula would be used to determine the percentage of total assistance allocated to each jurisdiction. The proxy formula used to allocate total assistance among the state jurisdictions could be derived from one of the proxy factor alternatives discussed in section IV.C. The amount of assistance directed toward carriers in a given state would reflect both the proxy factors (for example, the combination of a cost proxy -- such as population density -- and a general need proxy) as well as the total number of subscribers within the state. 73. Once the amount of assistance to be directed to each state jurisdiction has been established, the second step would involve determination of the amount of support for each individual recipient, depending upon the carrier's actual reported costs. This method could increase accountability, because most state assistance "pools" would consist of fewer than fifty study areas. At the same time, this alternative would appear to address the concerns raised by Vermont in its petition for waiver, because it would focus upon the general needs and characteristics of the state as a whole, without distinguishing between large and small carriers. In the paragraphs that follow, we invite comment on three alternative means of distributing high-cost assistance following allocations to state jurisdictions on the basis of proxy factors. 74. After Allocating High-Cost Assistance Among State Jurisdictions Based Upon Proxy Factors, Use Actual Reported Costs to Determine the Distributions to Individual Carriers. As we explained earlier in this Notice, there are differing advantages to the use of proxy factors and the use of actual reported costs to determine high-cost assistance. Proxy factors are intended to promote efficient investment and operation, but could deny assistance to individual high-cost carriers that do not meet the profile for assistance that forms the basis for the proxy factors. 75. In light of the respective advantages and disadvantages of using actual costs or proxy factors to distribute high-cost assistance, we wish to consider using a "mixed" method that would rely on one or more proxy factors to determine the total amount of high-cost assistance provided to each jurisdiction and then allocate that fixed sum on the basis of recipients' actual costs. We believe that this method could fairly distribute assistance among the various jurisdictions and, moreover, could promote accountability due to the interrelationship between the assistance provided to carriers within a single jurisdiction. We request comment upon this approach for determining high-cost assistance. 76. Allow Each State Commission to Establish Standards for Distributing High-Cost Assistance to the Carriers Within Its Jurisdiction. Another possible method would allow each state utility commission to administer the distribution of its state's high-cost assistance allocation. Allocations to the state jurisdictions would be determined by proxy factors, and the state utility commission would determine allocations from the state's high-cost assistance fund to individual carriers. State administration, under general guidelines promulgated by this Commission, could allow some variation among the distribution formulae used in various states, and thus could reflect cost characteristics unique to each state. 77. An advantage of this system is that a state commission is aware of the local service providers' network capabilities and the needs of the various communities within its jurisdiction. A state commission thus could adapt the general guidelines for high-cost assistance in order to serve the goals of universal service most effectively. We request comment upon state commission administration of distributing high-cost assistance to individual carriers. E. Establish a Voucher or Credit System for Telecommunications Users. 78. We invite interested parties to address the possibility of establishing a system whereby telecommunications users can claim high-cost assistance credits on their local service bills. We believe that this approach could eliminate any competitive advantage which the current rules afford traditional LECs. Proponents of such a system claim that the near future will see increasing competitive entry into local service markets, but that the existing high-cost assistance mechanisms may impede full and fair competition by giving the established LECs financial support denied to their competitors. Opponents claim that established LECs are the service providers of last resort and that, therefore, allowing credits to be used for service from competitors who are not required to offer ubiquitous service would be unfair, because the highest cost areas within a region would be left for the LEC to serve. We invite comment on this issue. 79. Given the likelihood of significantly expanding local service competition in the foreseeable future, we believe it prudent to consider replacing the existing high-cost assistance mechanisms with a system, based upon customer credits, that does not discriminate among providers of local telecommunications services. We request comment upon a two-step method for implementing a customer voucher system. The first step of this method would involve allocating high-cost assistance among state jurisdictions based upon proxy factors. After the nationwide high- cost assistance total is allocated among the states, the second step would require a determination regarding the amount of the credit or voucher available to customers in various locations within a state. We seek comment on this approach. 80. We also request that interested parties propose other alternatives for a voucher system that would encourage competition and decrease unnecessary subsidies while maintaining adequate support for customers and carriers needing assistance. In addition, we ask for specific comment upon the following issues: whether the amount of the customer credit should be uniform within each state jurisdiction, or whether it should vary based upon the needs of individual users or communities; and if the latter, what standards should be used in determining the amount of high-cost assistance credit. We seek comment upon the difficulty of administering a system affording credits to individual users. Finally, we request that interested parties comment upon whether customer vouchers should be available for all types of local services and, in addition, project the effect of such a system upon competition among established LEC service providers and prospective competitors. F. Need for Transition Mechanisms. 81. Many of the proposals for high-cost assistance contained in this Notice differ significantly from the present USF high-cost assistance mechanisms. While our goal is to improve the existing system of support for high-cost carriers, we are also mindful of the potentially disruptive effect upon individual LECs of implementing significant changes in either USF assistance or DEM weighting. 82. We invite comment upon the need for a transition period for gradually eliminating the current assistance mechanisms and gradually introducing any modifications or replacement mechanisms. We also request that interested parties propose an appropriate length of time for the transition process as well as the best means of accomplishing the transition with a minimum disruptive effect upon current recipients. V. PROCEDURAL MATTERS A. Ex Parte 83. This proceeding is exempt from ex parte restraints or disclosure requirements, as provided in Section 1.1204 of our rules. B. Comment Dates 84. We invite comment on the alternatives set forth above. Interested parties must file initial comments on or before October 28, 1994, and reply comments on or before December 2, 1994. To file formally in this proceeding, interested parties must file an original and four copies of all comments. If interested parties want each Commissioner to receive a personal copy of their comments, they must file an original plus nine copies. 85. Interested parties should send comments to: Office of the Secretary, Federal Communications Commission, Washington, D.C. 20554. Parties should also file one copy of any documents filed in this docket with the Commission's copy contractor, International Transcription Services, Room 640, 1990 M Street, N.W., Washington, D.C. 20036. We also ask that parties send a copy of their comments to each member of the Federal State Joint Board and its staff, as indicated in the attached service list. Comments will be available for public inspection during regular business hours in the FCC Reference Center (Room 239) of the Federal Communications Commission, 1919 M Street, N.W., Washington, D.C. 20554. For further information contact Deborah Dupont at (202) 418-0873. VI. ORDERING CLAUSE 86. Accordingly, IT IS ORDERED that, pursuant to Sections 1, 4(i), 4(j), 403, and 410(c) of the Communications Act of 1934, as amended, 47 U.S.C.  151, 154(i), 154(j), 403, and 410(c), an inquiry IS COMMENCED concerning possible proposals to change Part 36 of the Commission's Rules, 47 C.F.R. Part 36, as described above. FEDERAL COMMUNICATIONS COMMISSION William F. Caton Acting Secretary APPENDIX: HISTORY OF THE UNIVERSAL SERVICE FUND AND DEM WEIGHTING I. The Universal Service Fund 1. The concept behind establishment of the USF arose in 1982, as an outgrowth of proposed revisions to the jurisdictional separation of non-traffic sensitive ("NTS") exchange plant costs. The subscriber plant factor ("SPF"), the usage-based factor then used to allocate NTS costs between the interstate and intrastate jurisdictions, was causing increasing percentages of those costs to be allocated to interstate operations. Because NTS costs are not incurred on a usage-sensitive basis, we wished to consider replacing SPF with fixed allocation factors. 2. The Joint Board Staff (the Staff) urged that the successor to SPF be designed to reflect "the special needs of high cost areas," many of which had high interstate allocations under SPF. The Staff believed that without such adjustments for high- cost companies, those LECs would experience major shifts of NTS costs to their intrastate operations, causing large increases in local telephone rates. We therefore proposed to replace SPF with three new factors: a basic allocation factor, a high-cost factor to provide assistance to areas with high costs, and a transition factor "to minimize dislocations caused by moving away from the existing SPF basis." 3. In developing an appropriate replacement for SPF to allocate NTS local exchange plant, the Joint Board recommended "an equal percentage interstate allocation of NTS local exchange plant costs for all study areas in conjunction with appropriate protection for subscribers in high cost areas." The Joint Board proposed, and we adopted, the replacement of SPF with a 25 percent basic interstate allocation factor for NTS exchange plant costs. In addition, the Joint Board recommended the establishment of a banded high-cost support mechanism designed to provide a greater degree of assistance to LECs with the highest average NTS costs. The Joint Board suggested a transition period for phasing out SPF and phasing in the new basic allocation factor and high-cost factor. 4. The Joint Board determined that a high-cost support mechanism would "help protect the nationwide availability of telephone service at reasonable rates while limiting the amount to be recovered through carrier's carrier access charges." We found that the methodology recommended by the Joint Board represented "a sound balancing of concern for the promotion of universally available telephone service at reasonable rates and the need to prevent uneconomic bypass of the local exchange." We therefore adopted the high-cost support mechanism recommended by the Joint Board. 5. Concurrently with proceedings in this docket to revise the jurisdictional separation of NTS exchange costs, we were considering the adoption of interstate exchange access charges. At that time, a great deal of concern was expressed regarding the effect of the federal subscriber line charge ("SLC") upon customers of small telephone companies. As a result, we decided to defer the effective date of the federal SLC while the Joint Board considered a means of "increasing the assistance that is provided to customers of small companies in high-cost areas through the Universal Service Fund." After further proceedings in this docket, the Joint Board recommended that we establish a two-tiered system of assistance, whereby USF assistance would be increased for LEC study areas with fewer than 50,000 loops and decreased for study areas with more than 50,000 loops. We adopted the Joint Board's recommendation. 6. In 1986, we undertook an examination of the "cohesive package" of SLCs, lifeline programs, and high-cost assistance measures. We asked commenting parties to evaluate the effects of those three mechanisms and to consider whether revisions were needed in order to preserve universal service, promote economic efficiency, eliminate service pricing discrimination, and deter uneconomic bypass. After considering the comments and proposals submitted in response to our 1986 Notice, the Joint Board recommended, and we adopted, a retargeting of the high-cost assistance measures provided to telephone companies with high-cost study areas. Assistance to study areas with fewer than 200,000 loops was increased while assistance to larger study areas was decreased. The Joint Board's recommendation was premised upon an assumption that small companies have more need for assistance than larger LECs, which were believed to have greater flexibility in dealing with above-average costs. There was also evidence that the retargeting of the high-cost measures would decrease the overall size of the USF significantly. 7. Both the USF and the 25 percent basic allocation factor for NTS exchange plant costs were phased-in over a transition period lasting several years. Over the transition period, the basic allocation factor, supplemented by the USF factor for high-cost study areas, gradually replaced SPF. During 1993, the final year of the transition, both the 25 percent basic allocation factor and the USF assistance factor were at their full transition levels. II. DEM Weighting 8. In our 1984 Further Notice proposing additional high-cost assistance for small telephone companies, we also asked the Joint Board to undertake a comprehensive review of the jurisdictional allocation of costs associated with central office equipment ("COE"). We asked the Joint Board to focus on the continuing validity of the existing jurisdictional allocation methods for COE, particularly the method used to apportion costs associated with local dial switches, in light of the "major technological and engineering changes in COE since the last in- depth study of separations procedures." At that time, the cost of local dial switching equipment was split between traffic- sensitive ("TS") and NTS costs. The TS portion of such costs was allocated between the interstate and intrastate jurisdictions on the basis of relative dial equipment minutes of usage ("DEM"). Toll DEM were then weighted for each office on the basis of a toll weighting factor intended to reflect, for the particular type of switching equipment, estimated cost differences per minute of use for toll and local usage. 9. In 1987, the Joint Board found that changing technology and the introduction of digital switching had made it hard to justify treating some local switching equipment costs as TS and others as NTS. The Joint Board therefore recommended that the distinction be eliminated and that the costs of local switching equipment be treated as TS and allocated between the jurisdictions on the basis of relative usage, using measured DEM. The Joint Board rejected the use of a DEM toll weighting factor, finding that "modern digital switching equipment has greatly reduced, if not eliminated, the additional cost of toll switching." The Joint Board further proposed a five-year transition period beginning in 1988. 10. The Joint Board recommended, however, that assistance be provided to small study areas in order to offset potential cost shifts to intrastate operations triggered by the transition to DEM. The Joint Board's plan did not propose to include such assistance as part of the USF, but instead involved a separate means of assistance via weighting of the DEM factors for small companies. Depending on the number of their access lines, small study areas would be allowed to use a DEM weighting factor of 2.0, 2.5, or 3.0. Only study areas with 50,000 or fewer access lines were to be eligible to use the weighting factors, because the Joint Board determined that "a carrier with 50,000 to 200,000 subscriber loops does not qualify as a small carrier." 11. We adopted the Joint Board's recommendations for the use of DEM to allocate local switching costs and for the establishment of DEM weighting factors in order to provide assistance to small companies. We also approved the Joint Board's plan for a five-year transition to DEM weighting. The last year of that transition period was 1992; therefore, as of 1993, DEM and the DEM weighting factors for small study areas were at their full transition level. FEDERAL-STATE JOINT BOARD SERVICE LIST The Honorable Dennis J. Nagel, Chairperson Iowa Utilities Board Lucas State Office Building Des Moines, Iowa 50319 The Honorable Sharon L. Nelson, Chairman Washington Utilities and Transportation Commission Chandler Plaza Building 1300 South Evergreen Park Drive, S.W. Olympia, Washington 98504-7250 The Honorable Cheryl L. Parrino, Chair Wisconsin Public Service Commission Post Office Box 7854 Madison, Wisconsin 53707-7854 The Honorable Lilo K. Schifter, Commissioner Maryland Public Service Commission 6 St. Paul Centre Baltimore, Maryland 21202 The Honorable James H. Quello, Commissioner Federal Communications Commission 1919 M Street, N.W. - Room 802, Stop 0106 Washington, D.C. 20554 The Honorable Andrew C. Barrett, Commissioner Federal Communications Commission 1919 M Street, N.W. - Room 826, Stop 0105 Washington, D.C. 20554 Sandra Makeeff, State Joint Board Staff Chair Iowa Utilities Board Lucas State Office Building Des Moines, Iowa 50319 Deborah A. Dupont, FCC Joint Board Staff Chair Federal Communications Commission Common Carrier Bureau - Accounting & Audits Div. 2000 L Street, N.W. - Room 257 Washington, D.C. 20036 Elton Calder Georgia Public Service Commission 162 State Office Building 244 Washington Street, S.W. Atlanta, Georgia 30334 Ronald Choura Michigan Public Service Commission 6545 Mercantile Way Lansing, Michigan 48910 Rowland Curry Texas Public Utility Commission 7800 Shoal Creek Blvd. - Suite 400N Austin, Texas 78757 Ann Dean Maryland Public Service Commission 6 St. Paul Centre Baltimore, Maryland 21202 Dean Evans California Public Utilities Commission 505 Van Ness Avenue - Room 4004 San Francisco, California 94102 Robert Hall Federal Communications Commission Common Carrier Bureau - Accounting & Audits Div. 2000 L Street, N.W. - Room 812 Washington, D.C. 20036 Robert Loube Public Service Commission of District of Columbia 450 Fifth Street, N.W. Washington, D.C. 20001 Sam Loudenslager Arkansas Public Service Commission 1000 Center Street Post Office Box C-400 Little Rock, Arkansas 72203 Thomas McCabe Florida Public Service Commission 101 East Gaines Street Fletcher Building Tallahassee, Florida 32399-0850 Paul Pederson Missouri Public Service Commission Post Office Box 360 Jefferson City, Missouri 65102 Teresa Pitts Washington Utilities and Transportation Commission 1300 South Evergreen Park Drive, S.W. Olympia, Washington 98504-7250 James Bradford Ramsay National Association of Regulatory Utility Commissioners 1102 ICC Building Constitution Avenue & 12th Street, N.W. Post Office Box 684 Washington, D.C. 20044 Jeff Richter Wisconsin Public Service Commission Post Office Box 7854 Madison, Wisconsin 53707-7854 Gary Seigel Federal Communications Commission Common Carrier Bureau - Accounting & Audits Div. 2000 L Street, N.W. - Room 812 Washington, D.C. 20036 Joel B. Shifman Maine Public Utilities Commission State House Station # 18 Augusta, Maine 04333 Fred Sistarenik New York Public Service Commission 3 Empire State Plaza Albany, New York 12223 Mary Steele North Carolina Utilities Commission Box 29510 Raleigh, North Carolina 27626-0510