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Remarks by Chairman Reed Hundt

Before the United State Telephone Association

Inside Washington Telecommunication Roundtable Luncheon

May 21, 1997

It's a pleasure to see you today. At his anniversary dinner last month, Jim Quello said that in his 23 years at the FCC, he'd had a chance to vote against everyone in the room at least twice. Now, I've done that in just three years. See how efficient we're getting at the FCC.

All our votes are intended to be pro-competition, not pro-competitor. Our decisions are not designed to select winners or losers. Winners and losers will be determined where they should be determined -- in the competitive marketplace, not in government.

As an independent regulatory agency, our job is to implement Congress's will as expressed in the law. Our guiding principles are: "Read the Law, Study the Economics, Do the Right Thing."

Above all, doing the right thing means rigorously following the dictates of the Telecommunications Act and implementing fully the intent of Congress.

In our recent universal service and access reform decisions, doing the right thing means reforming access pricing methods in order to promote efficient competition by both competitors and incumbents. Our orders move to more flat rate pricing for this reason. We have chosen a primarily market-based approach to reducing access charges for price-capped carriers, rather than the prescriptive regulatory method urged by many parties.

Doing the right thing also means ensuring universal service. Congress set forth in Section 254 the social goals it wanted the Federal-State Joint Board and the Commission to meet and advance. Our decision advances all such goals dictated by the Act, including: ensuring affordable service in high cost areas, providing low income assistance, and connecting America's schools, libraries, and rural healthcare providers.

Doing the right thing means embracing Congress's view that universal service includes bringing 21st century communications to our country's classrooms and rural health clinics. Congress recognized that investing in our future through education and healthcare will provide significant long term benefits for the economy. These new markets -- schools and rural healthcare providers -- will also provide significant business opportunities for all of you.

Some people have already criticized our orders for not doing enough. Some for doing too much. And, some even criticize us for both!

Here's what we have done: we have instituted a framework for competition and universal service that is mandated by the Telecommunications Act. We have created a state-federal procedure to do cost studies that will determine the amount of high cost support necessary to preserve and advance universal service. We have acknowledged that interstate access rates will go down as federal high cost support for large LECs is sized. We have reformed interstate access charges in a way that reduces the likelihood that competitors can avoid access charges by selling to only a few very high volume customers. We did this without price shock for consumers or revenue shock for businesses.

One analyst said that "The unvarnished answer is that Congress sent the FCC an inherently contradictory Telecom Act to implement with an impossible set of conflicting political expectations." We think that the Act's common sense meaning is much clearer than that. We are supposed to reconcile pro-competition principles with universal service.

I'm going to spend the balance of my time talking about how our decisions did that.

Let's begin with the small LECs -- the vast majority of phone companies out there today and the backbone of telephone service in rural America. You serve anywhere from a few hundred to several thousand access lines each, typically in rural, high cost areas. You are under rate of return or average schedule regulation. And you don't have the economies of scale larger companies have. You live in the community your company serves and you've got every reason to question what goes on in Washington.

For you and your customers, I believe that our decisions are welcome news.

We didn't lower the current level of universal service support provided to small LECs. You don't lose the amounts you currently receive from DEM weighing, long term support or from the existing high cost fund. And universal service support will continue to grow to reflect new investment.

We didn't change your interstate access revenues. The access charge reductions and rate structure changes that apply to the price cap LECs don't affect you at all. In fact, I wouldn't be surprised if your access revenues are actually increased by our actions because our reduction of retail long distance prices will stimulate additional calling.

We did not, despite the Joint Board's recommendation, freeze high cost support based upon 1995 investment. Instead, we will continue to distribute high cost support according to existing formulas, which will allow support to rise in 1998 and 1999 based upon investments made in 1996 and 1997. For the year 2000, we have adopted a proposal by small telephone company associations to adjust the level of support by inflation.

So what did we do?

We created a more efficient means of providing rural LECs with universal service support at current levels, meaning that you will continue to receive approximately $1.3 billion in annual high cost support. We created universal service funding for classrooms, libraries and rural healthcare providers -- and you will get a large share of it.

Over the longer term, while we will continue to work with the states to develop a high cost support mechanism for rural LECs based on principles of forward looking economic cost, we will not implement such a mechanism for rural carriers until "we have sufficient validation that forward-looking support mechanisms for rural carriers produce results that are sufficient and predictable," and in no event before 2001.

We will establish a rural task force to identify issues unique to rural carriers. We recognize that unique issues faced by rural LECs suggest that different rules may be appropriate for small rural telcos during the transition to competition.

The rural exemption to the local competition rules means that competition cannot come to your areas until state commissioners decide to allow it.

I want to re-emphasize a significant opportunity for rural LECs. Many of you will participate in a major way in the extension of the information superhighway to classrooms, libraries and rural healthcare providers. The program that we have established, pursuant to Congress's mandate and consistent with the recommendations of the Federal-State Joint Board on Universal Service, is ambitious. Federal support combined with existing spending by schools and libraries represents a market of nearly $20 billion over the next five years. Remember, this isn't money that includes software or computers. All of this is funding that will be spent on telecommunications services and inside wiring.

This is right up your alley. Many of you have already done much for education in your communities. You can build on your history and make money doing so.

As for the larger LECS, such as the Bell companies and GTE, let's review the reviews.

Dan Reingold of Merrill Lynch:

"The FCC's decision is excellent for local phone companies, incumbents and new entrants....we (and the consensus) have no need to lower EPS estimates for the RBOCs..."

According to Frank Governali of Credit Suisse/First Boston:

"As FCC officials have been saying to anyone willing to listen, no actions it would take would be surprising ... or automatically favor one industry sector over another. We think the FCC hit the mark."

From Peter Kennedy of Morgan Stanley

"[T]he FCC decision should come as a relief for the entire telecom services group."

And Bill Garrahan of Lehman Brothers:

"On an industry-wide basis, we view this as positive news, especially for the RBOCs and LECs whose stocks have been depressed on the fears of large access cuts."

From Anna Maria Kovacs of Janney Montgomery Scott:

"Bottom line: remarkably even-handed....It is difficult for us to find areas [in the decisions] that the LECs could complain about."

Wall Street's best and brightest say these orders make good sense, and in the six weeks between April 8th and May 19th, the RBOCs and GTE are up about 8%.

But let me turn to the specifics and walk you through why Wall Street has already concluded that our decisions are good news for the local exchange industry.

I'll begin with what I think is the most important point to understand here: for the large LECs, in absolute terms, the reduction that will occur on July 1, 1997, represents only about $750 million more than would have happened in any event. That's a change of about 3% in interstate access revenues or less than 1% of total price cap LEC revenues, and that's without taking into account stimulation or growth caused by the price cuts.

Moreover, the reduction in access is well within the range anticipated by virtually every party watching the debate. I've already showed what Wall Street had to say on this point: one report was even titled "Access Charge Reform: No Surprise..." The decrease that we've ordered is also much less than the cuts embraced by Bell Atlantic and NYNEX, who argued for cuts totalling over $2.25 billion as part of their joint proposal with AT&T.

And the rate changes that result from our changes to the productivity factor under price caps -- the so-called X-factor -- are prospective only. We're not changing last year's rates and we're not ordering refunds.

Now you can understand my bewilderment when my friend Roy Neel writes to every Member of Congress just this past week that "The gaping hole left in the support for universal service by arbitrarily reducing access charges before this plan is complete will jeopardize universal telephone service." Roy is an able advocate and dear friend. This time, however, I think he's simply gotten it wrong.

Of course even if I disagree, this is a serious charge, and one that we do not take lightly, given our commitment to ensuring robust, sustainable universal service. So I'll address his concerns in detail.

The thrust of Roy's letter is that we have somehow endangered universal service by reducing access and permitting companies to bypass access with unbundled network elements.

There are many reasons why these assertions are incorrect.

Let me be very clear: The reductions in interstate access to account for better calculation of large LEC productivity do not cut into universal service support that is part of access. After all, we're talking about companies with average rates of return in the 15% range, so the idea that a cut in total revenues of less than 1% would impact universal service is not credible.

Even if this reduction in interstate access levels somehow creates a problem for a given LEC, our new price cap rules include a low end rate of return floor of 10.25%. This ensures that price cap LECs will continue to earn sufficient returns to assure universal service.

As part of our access reform NPRM, we also commenced our examination of the so-called historic cost issue. After all, the claims about underfunding universal service are really about whether the large price cap LECs are earning sufficient returns on their historic investments, not whether there's sufficient cash flow to keep the phones running in a high cost area.

The balance of USTA's letter suggests that competition from competitors who purchase unbundled network elements is also a threat to universal service.

Before answering this argument, I should be clear about whose issue this is: it matters only to the price cap LECs subject to our unbundling requirements. Most companies are still exempt from those requirements.

As to the substance of this concern, there is simply no evidence that the sky is falling. Losses to competition through lease of unbundled elements are virtually non-existent at this stage. It's not even clear that the Bell companies and GTE are yet providing network elements -- especially network elements bundled together -- on a scale that poses a significant competitive threat at this time. Moreover, even when a LEC loses a customer to UNEs, that competitor pays the LEC for unbundled elements. The LEC also sheds some retail costs, meaning that the ultimate effect on the LEC is less than you otherwise might suppose.

Again, I suspect that the real issue here is historic cost recovery, something we will cover in a separate proceeding very soon.

Given the fact that current access revenues are only moderately impacted by our decision that we are retaining our 10.25% rate of return floor, we see no need to respond prematurely to a hypothetical description of the potential impact of UNE-based competition on universal service. However, if there is solid evidence that this problem is real and requires an immediate solution, we will act immediately to solve it.

So those are reasons why I think my friend Roy is mistaken in his recent letter. But let me turn the tables and talk a little bit about what the LECs would have us do instead. Their answers seem to fall into two camps:

The first camp would have us create a large high cost fund immediately (notwithstanding clear problems and the lack of consensus over the cost proxy models) and would have us raise the money from both the interstate and intrastate jurisdictions. I think we know what the result of such a plan would be -- higher basic residential phone rates.

Incidentally, virtually all the phone companies asked us to raise the SLC at the beginning of this proceeding. And that is exactly what Congress didn't have in mind when it adopted this legislation.

The second camp, comprised primarily of large LECs without many high cost areas, would have us create a much smaller fund collected on the basis of interstate revenues only. But this would be ill advised if universal service subsidy fell short of what is necessary and if states could not support intrastate network costs solely through rates charged for intrastate services without jeopardizing affordability.

As LECs do not agree, so we see that this is a difficult issue. We could all use the next half-year to seek consensus.

I think the core of this debate is about sizing high cost support correctly. After all, if you get that right, the claims about access cuts and competitive threats to existing revenue streams that provide subsidy will be less vehement. That's why we've taken the issue of calculating the cost of universal service support for high cost areas so seriously. That's why we plan to work with the states and other interested parties over the coming year to get the high cost funding sized correctly. This means working with those states that choose to submit studies of the cost of universal service in their states, and developing an acceptable means of determining cost where a state elects not to do so.

We can't just guess here in part because overestimating the size of the fund has significant adverse consequences for competition and efficiency. Universal service subsidies are far less easily competed away than the implicit subsidies that are part of per minute, and now per line, access charges. Any dollars that actually represent monopoly profits or inefficiency that wind up in the universal service fund are there to stay. The risk from the fund being too large is that monopoly profits and inefficiency are made a permanent part of the telephone network's economics, to the detriment of consumers or competitors. That's why spending a bit more time to get the sizing right is important.

In the meantime, as I've discussed, we didn't over aggressively reduce the implicit subsidy; we provided a low-end rate of return floor; we have commenced an historic cost proceeding and we stand ready to hear any claims that competition is right now overwhelming your ability to provide universal service.

So I've talked about why we believe that the forecasts of doom based on universal service and access reform items are way overblown. Now I'd like to spend a little time on the components of our decisions that are clearly positive for the LECs but which have received considerably less airtime than the complaints.

First among these is surely the eligibility for new business from connecting and serving schools, libraries and rural healthcare providers. Many LECs have done an admirable job on this front already, which positions them perfectly for taking advantage of this expanded market.

Of course, some (such as USTA) have complained that other parties, including some non-LECs, are eligible for funding under our universal service decision. They're right, but it only means that LECs will have to compete for these education and healthcare dollars if they want them--hardly an unreasonable request. As a matter of fact, I'd bet that any one of your competitors would gladly trade spots with you in this market given your brands, your relationships, and other assets that you bring to the table.

Another important component of what we did is reducing the vulnerability of LECs to cream skimming. Everyone agrees that restructuring access charges by moving toward lower per minute rates in favor of per line charges helps LECs reduce their vulnerability to cream skimming new entrants. This is part of our effort to move to a more rational rate structure and it's a clear benefit to the price cap LECs.

I should spend just a minute before I close talking about some of the things we have on tap for the coming months. Our Order providing access pricing flexibility to price cap LECs should be out by the end of June. We are also planning to release shortly an NPRM on continuing incentives for innovation. Finally, as I've already discussed, our proceeding on historic cost will address many of the issues that have been raised in the context of the interconnection and universal service decisions.

Ultimately, I think that you'll find our policies will be pro-competitive and deregulatory and those of you who are most inclined to compete for the new opportunities created by the Telecom Act will do best.

Thank you.