Intercarrier Compensation: One Component of Telecom Reform

CRS Report for Congress
Intercarrier Compensation:
One Component of Telecom Reform
April 28, 2005
Charles B. Goldfarb
Specialist in Industrial Organization and Telecommunications Policy
Resources, Science, and Industry Division

Congressional Research Service ˜ The Library of Congress

Intercarrier Compensation:
One Component of Telecom Reform
Summary
Nondiscriminatory intercarrier compensation — the payments that
interconnected carriers make to one another when more than one carrier’s network
must be used to complete a telephone call or other electronic communication — is
the linchpin of a competitively neutral regulatory regime. Under current statutory
requirements and regulatory rules, these payments vary widely (from 0.1 cents to 5.1
cents per minute), depending on whether the interconnecting party is a local
exchange carrier, a long distance carrier, a wireless carrier, or an information service
provider, and whether the service is classified as telecommunications or information,
local or long distance, or interstate or intrastate — even though in each case basically
the same transport and switching functions are provided.
There is general agreement that in today’s competitive environment, intercarrier
compensation reform is needed because the current regime:
– distorts investment decisions and undermines efficient competition by
providing artificial advantages/disadvantages to those service providers that
happen to be subject to favorable/unfavorable intercarrier compensation rules;
– fails to provide innovators certainty about the intercarrier compensation regime
to which their services will be subject;
– encourages uneconomic arbitrage — that is, providers making business
decisions based on the artificial rates set for intercarrier compensation, rather
than on true underlying costs;
– creates an artificial cost structure, based on minutes of use, which appears to
be inconsistent with actual cost causation in networks and which renders it
difficult for carriers to meet the preferences of many consumers for offerings
consisting of large baskets of minutes or unlimited calling at a fixed price;
– requires carriers to expend millions of dollars and scarce information
technology resources developing systems to identify, measure, monitor, bill,
reconcile, audit, and dispute the classification of traffic; and
– undermines the stability of universal service subsidy funds.
At the same time, in some quarters there is resistance to comprehensive
intercarrier compensation reform because of concerns that some carriers and some
consumers may be harmed by the changes.
– Reform is likely to result in an increase in end-user subscriber line charges,
which consumer groups argue would unfairly burden low usage and low income
customers.
– Reform is likely to reduce the intercarrier compensation revenues of rural local
exchange carriers and increase their need for universal service funding at a time
when rural wireless carriers also are seeking access to a potentially limited
amount of total universal service funds.
– Reform is likely to require modification of intrastate intercarrier compensation
rates, but since these have been within the jurisdiction of state regulatory
commissions, some observers have questioned whether the Federal
Communications Commission can undertake such reform without active state
involvement.
This report will not be updated.

Contents
Overview ........................................................1
Historical Background..............................................8
Comprehensive Intercarrier Compensation Reform: Key Issues.............11
Should the called party share the cost burden with the calling party?.....12
Why this matters.........................................12
Analysis and discussion....................................13
Where should networks be allowed, or required, to interconnect with one
another? ................................................18
Why this matters.........................................18
Analysis and discussion....................................18
What is the underlying cost structure of the transport and switching functions?
.......................................................21
Why this matters.........................................21
Analysis and discussion....................................22
What system is needed for setting intercarrier compensation rates for
intermediate (transit) networks?.............................25
Why this matters.........................................25
Analysis and discussion....................................25
How can intercarrier compensation reform take into account the special needs
of rural carriers and universal service funding?..................29
Why this matters.........................................29
Analysis and discussion....................................29
Can intrastate intercarrier compensation rates and rate structure be modified by
federal action?...........................................32
Why is intercarrier compensation regulation not needed for the networks that
comprise the Internet?
.......................................................32
Overarching Issue: How Can the Complexities of Intercarrier Compensation be Most
Effectively Addressed in Statutes and in FCC Regulations?............33
List of Figures
Figure 1: Current Intercarrier Compensation Rates....................3
Figure 2. Simple Telephone Call Over Two Carriers’ Networks.........14

Intercarrier Compensation: One Component
of Telecom Reform
Overview
Over the past 30 years, telecommunications policy in the United States slowly
has evolved from government sanctioned monopoly provision of all
telecommunications services to competitive provision of most telecommunications
services. Congress explicitly mandated this competitive market approach in the
Telecommunications Act of 1996.¹ These competing providers have had to
interconnect their networks and, today, most telephone calls and electronic
communications travel over more than one carrier’s network to get from the calling
party to the called party. Since the calling party only pays the carrier to which it
subscribes for service, a system of intercarrier compensation has been needed to
compensate any other carrier whose network facilities are used to complete the call.
The telecommunications sector today is characterized by the deployment of new
digital technologies that are driving the convergence of previously distinct markets.
These new technologies are being deployed in — and carried over — wireline,
wireless, and cable networks that are becoming increasingly capable of providing
voice, data, and video services over a single broadband platform. With these new
technologies, costs are no longer driven by distance, and traffic no longer stays within
national boundaries, no less state or local boundaries. There is a consensus that the
current framework of telecommunications statutes and regulatory rules, based on
outdated classifications that do not conform to marketplace realities, no longer fosters
such fundamental public policy objectives as competition, universal service, and
rapid innovation.
Perhaps the most significant such set of legacy rules involves intercarrier
compensation, which affects telecommunications competition, innovation, and
efficiency, as well as the universal availability of telecommunications services.
Nondiscriminatory interconnection is a prerequisite for competitive
telecommunications markets and nondiscriminatory intercarrier compensation is the
linchpin of a competitively neutral regulatory regime.
The current system of intercarrier compensation was implemented on a
piecemeal basis, as specific existing telecommunications services were opened to
competitive provision or providers offering entirely new services (such as wireless
service) were allowed to interconnect with the public switched telephone network.
Today, these intercarrier compensation payments vary widely, depending on:

¹ Telecommunications Act of 1996, P.L. 104-104, 110 Stat. 56 (“1996 Act”).

^!whether the interconnecting party is a local exchange carrier
(“LEC”),² an interexchange (long distance) carrier, a commercial
mobile radio service (“CMRS” or wireless) carrier, or an
information service provider (“ISP”), and
^!whether the service is classified as telecommunications or
information, local or long distance, or interstate or intrastate,
even though in each case basically the same transport and switching functions are
provided.
As shown in Figure 1, a chart prepared by the Intercarrier Compensation Forum
(“ICF”),³ today the average intercarrier compensation rate ranges from 0.1 cents per
minute for traffic bound to an ISP to 5.1 cents per minute for intrastate traffic bound
to a subscriber of a small (rural) incumbent local exchange carrier; individual rates
can be as low as zero and as high as 35.9 cents per minute.⁴ These intercarrier
compensation charges can represent a substantial portion of the costs of providing
certain services and, in the case of long distance calls that interexchange carriers are

² These payments vary even among LECs, depending on whether the carrier is an incumbent
local exchange carrier (“ILEC”), that is one of the legacy LECs that was a government
sanctioned local monopoly provider prior to the implementation of the 1996 Act; a small
LEC (sometimes referred to as a rural LEC), that is an ILEC serving a small rural area; or
a competitive local exchange (“CLEC”), that is a new competitive provider of local
exchange service that was allowed to enter the market as a result of enactment of the 1996
Act.
³ The ICF is a group of carriers from different segments of the telecommunications industry
that has submitted a proposal for comprehensive intercarrier compensation reform, In the
Matter of Developing a Unified Intercarrier Compensation Regime, CC Docket No. 01-92,
Ex-Parte Brief of the Intercarrier Compensation Forum in Support of the Intercarrier
Compensation and Universal Reform Plan (“ICF Plan”), October 5, 2004.
⁴ ICF Plan at Appendix C, p. 2. In Figure 1, “RC” refers to “reciprocal compensation,”
the cost-based system for intercarrier compensation between providers of local service
mandated by the 1996 Act (47 U.S.C. §§ 251(b)(5), 252(d)(1)(A), and 252(d)(2)(A)).
“IntraMTA” and “InterMTA” refer to the distinction between those calls originating on
wireless networks that are treated as local vs. long distance for intercarrier compensation
purposes, as discussed in greater detail below. All classifications with the words
“intrastate” or “interstate” refer to intercarrier compensation rates for long distance calls.

required by statute and Federal Communications Commission (“FCC”) rule to offer
at a single rate nationally,⁵ can exceed the retail price for the service.⁶
Figure 1: Current Intercarrier Compensation Rates

Source: Intercarrier Compensation Forum
Given the wide variation in intercarrier compensation rules applied to carriers
and technologies that are now competing with one another, the FCC adopted a
⁵ In section 254(g) of the 1996 Act, 47 U.S.C. § 254(g), Congress instructed the FCC to
“adopt rules to require that the rates charged by providers of interexchange
telecommunications services to subscribers in rural and high cost areas shall be no higher
than the rates charged by each such provider to its subscribers in urban areas. Such rules
shall also require that a provider of interstate interexchange telecommunications services
shall provide such services to its subscribers in each State at rates no higher than the rates
charged to its subscribers in any other State.” To implement this statutory instruction, the
FCC adopted a geographic rate averaging rule and a rate integration rule. (47 C.F.R. §

64.180.)

⁶ The “access charges” that some rural local exchange carriers charge long distance carriers
for originating the long distance calls made by customers located in those rural areas, or for
terminating the long distance calls made to customers located in those rural areas, exceed
the nationally averaged price that the long distance carriers charge their subscribers for those
calls, and thus the long distance carriers lose money on each long distance call into or out
of those rural exchanges. As a result, long distance carriers are reluctant to make available
to customers in those areas service packages that are likely to be attractive to heavy long
distance users.

Further Notice of Proposed Rulemaking in February 2005 to review and reform its
rules with the goal of constructing a unified intercarrier compensation regime.⁷ The
FCC seeks public comment on nine comprehensive intercarrier compensation reform
proposals or sets of principles that have been submitted to the FCC as well as a staff
proposal.⁸ The issues raised in the ICC FNPRM are not new to the Federal
Communications Commission. In 2001, the FCC opened a rulemaking proceeding
and adopted a Notice of Proposed Rulemaking seeking information on how to
develop a unified intercarrier compensation regime.⁹
There is general agreement that intercarrier compensation reform is needed
because:
^!The current regime distorts investment decisions and undermines
efficient competition by providing artificial
advantages/disadvantages to those service providers that happen to
be subject to favorable/unfavorable intercarrier compensation rules.
For example, for non-local calls made within any of the 51
Metropolitan Trading Areas (“MTAs”) in the United States,¹⁰ if the

⁷ In the Matter of Developing a Unified Intercarrier Compensation Regime, Further Notice
of Proposed Rulemaking (“ICC FNPRM”), adopted February 10, 2005, released March 3,

2005.

⁸ See the following documents filed with the FCC in the Intercarrier Compensation
proceeding: The National Association of Regulatory Utility Commissioners (“NARUC”)
Study Committee on Intercarrier Compensation Goals for a New Intercarrier Compensation
System, May 5, 2004; Cost Based Intercarrier Compensation Coalition (“CBICC”) Proposal,
September 2, 2004; Ex Parte Brief of the Intercarrier Compensation Forum in Support of the
Intercarrier Compensation and Universal Service Reform Plan, October 5, 2004; The
Intercarrier Compensation and Reform Plan of the Alliance for Rational Intercarrier
Compensation, October 25, 2004; A Comprehensive Plan for Intercarrier Compensation
Reform Developed by the Expanded Portland Group, November 2, 2004; Western Wireless
Intercarrier Compensation Reform Plan, December 1, 2004; Updated Ex Parte of Home
Telephone Company, Inc. and PBT Telecom, November 2, 2004; Ex Parte of CTIA — The
Wireless Association, November 29, 2004; the National Association of State Utility
Consumer Advocates (“NASUCA”) Intercarrier Compensation Plan, December 17, 2004;
“A Bill-and-Keep Approach to Intercarrier Compensation Reform,” ICC FNPRM, Appendix
C.
⁹ In the Matter of Developing a Unified Intercarrier Compensation Regime, Docket No. 01-

92, Notice of Proposed Rulemaking (“ICC NPRM”), 16 FCC Rcd at 965.

¹⁰ Rand McNally & Co. has formulated 493 non-overlapping Basic Trading Areas
(“BTAs”) that cover the entire United States and its territories. Each BTA represents a
geographic region, defined by a group of counties that surround a city, which is the area’s
basic trading center. The FCC has used these BTAs to determine service areas for PCS
wireless licenses. In turn, these 493 BTAs are aggregated into 51 Major Trading Areas
(“MTAs”), usually composed of several contiguous basic trading areas. Individual MTAs
are quite large, and can encompass several states. For a map showing the MTA boundaries,
see [http://wireless.fcc.gov/auctions/data/maps/mta.pdf] (viewed on 4/14/05). The
intercarrier compensation rules are different for intraMTA wireless calls that originate and
terminate within an MTA and interMTA wireless calls that originate and terminate in
(continued...)

caller uses a wireless telephone, the caller’s wireless carrier is
subject to a cost based “reciprocal compensation” charge for the
termination of that call; but if the caller made an identical call, from
the same location to the same called party, using a wireline
telephone (and hence a wireline long distance carrier), that carrier
would be subject to an above cost “access charge” for the
termination of the call. As another example, when a long distance
call is made to a called party’s wireline telephone, that party’s
wireline local exchange carrier can charge the calling party’s long
distance carrier an above cost access charge for terminating the call;
but if an identical long distance call were made to the same called
party, from and to the same physical location, but to the called
party’s wireless telephone, the called party’s wireless carrier is not
allowed to charge the calling party’s long distance carrier any access
charge for terminating the call.
^!The current regime fails to provide innovators certainty about the
intercarrier compensation regime to which their services will be
subject. For example, since voice over Internet protocol (“VoIP”)
service is, on one hand, an application of an information service and,
on the other hand, functionally equivalent to a traditional voice
telephone call, it arguably fits into two different classifications for
the purposes of intercarrier compensation. Information services are
not subject to access charges; long distance telephone calls are. The
business plans of VoIP providers will be strongly affected by the
ultimate decision about how they are classified for intercarrier
compensation purposes.
^!The current regime encourages uneconomic arbitrage — that is,
providers making business decisions based on the artificial rates set
for intercarrier compensation, rather than on true underlying costs.
For example, because of the traffic patterns of ISPs and some
anomalies in the rules,¹¹ some CLECs have pursued the market
strategy of targeting ISPs as customers. They have offered ISPs
service at what may have been below-cost rates because they could
more than recoup any losses by charging above-cost rates to the
carriers of the ISPs’ subscribers for terminating the large volume of

¹⁰ (...continued)
different MTAs.
¹¹ Specifically, (1) ISPs are treated like end users; (2) ISPs receive far more calls than they
make, so an ISP’s LEC will terminate far more calls from the ISP’s subscribers than it
originates from the ISP; (3) for many of those terminated calls, the ISP’s LEC can charge
the carriers serving the ISP’s end user customers above-cost access charges; and (4) the
ISP’s LEC can choose a single point of interconnection with the carriers serving the ISP’s
end user customers in a way that requires those carriers to bear most of the costs of
transporting the traffic to the ISP. The specifics of this are discussed in the section below
on “Where should networks be allowed, or required, to interconnect with one another?”

subscriber calls to those ISPs.¹² Regulators also may seek to exploit
uneconomic arbitrage. For example, state regulators as well as rural
LECs may have the incentive to limit the scope of rural local calling
areas since calls that are classified as long distance will generate
more revenues (through toll charges or access charges) than they
would if classified as local and also will tend to move the burden of
cost recovery from local rural customers to urban long distance
customers (since long distance rates are averaged and thus urban
customers who can be served at low cost face higher averaged rates
that contribute to the recovery of higher rural costs).
^!The current regime creates an artificial cost structure, based on
minutes of use, which appears to be inconsistent with actual cost
causation in networks and which renders it difficult for carriers to
meet the preferences of many consumers for offerings consisting of
large baskets of minutes or unlimited calling at a fixed price. For
example, under the current access charge regime, interexchange
carriers are charged on a per-minute-of-use basis for the switching
used to originate and terminate their customers’ calls, making the
interexchange carriers’ underlying cost structure usage-sensitive
even though the preponderance of those switching costs appear not
to be usage-sensitive.¹³ But by facing these artificially imposed
usage-based costs, long distance carriers are discouraged from
offering large baskets of minutes or unlimited calling at a fixed price
since they would lose money when serving high usage customers,
who are the customers most likely to select such packages.¹⁴
^!The current regime requires carriers to expend millions of dollars
and scarce information technology resources developing systems to
identify, measure, monitor, bill, reconcile, audit and dispute the

¹² In its 2001 ISP Report and Order, the FCC found that “under the current carrier-to-carrier
recovery mechanism, it is conceivable that a carrier could serve an ISP free of charge and
recover all of its costs from originating carriers.” The ILECs were somewhat constrained
in their ability to compete with the CLECs for these ISP customers because in certain
situations they are not allowed to negotiate individual contracts with customers, but rather
are limited to offering services through tariffs that are generally available to all customers.
¹³ A more detailed discussion of switching costs in presented below in the section entitled,
“What is the underlying cost structure of the transport and switching functions?”
¹⁴ The long distance carriers assert that the Bell operating companies, which are now
allowed to offer long distance service and typically do so as part of a package of local and
long distance service, do not face the same problem. The long distance carriers claim that,
even if the Bell companies’ long distance arms must pay the same usage-based access
charges to their local operating companies as the long distance carriers pay, the underlying
costs to the Bells are not usage-sensitive. That is, any losses that the Bells’ long distance
arms might suffer, when serving a high usage customer, by having to pay minute-of-use
access charges while offering large baskets of minutes or unlimited calling at a fixed price,
are matched by the additional profits that the Bells’ local operating companies generate from
those minute-of-use access charges (since their underlying costs are not increasing with
usage).

classification of traffic as local or toll, intrastate or interstate,
intraMTA or interMTA,¹⁵ information service or
telecommunications service, etc., in order to determine which
intercarrier compensation rules apply. It also encourages wasteful
litigation as carriers fight among themselves about that classification
of traffic. These costly nonproductive activities will continue to
grow as providers respond to consumer demand for bundled
offerings of services that fit into different classifications.
^!The current regime undermines the stability of universal service
subsidy funds. Where ILECs rely at least in part on the profits from
above cost access charges to defray the cost of providing universal
service, this funding source is in jeopardy because the number of
minutes subject to access charges is declining as carriers with more
favorable intercarrier compensation treatment (for example, wireless
and VoIP carriers) are gaining market share and traditional long
distance carriers have an incentive to manipulate the complex
packages of services that they offer to minimize their exposure to
access charges.
At the same time, in some quarters there is resistance to comprehensive
intercarrier compensation reform because of concerns that some carriers and some
consumers may be harmed by the changes. In this view:
^!If the access charges currently imposed by local exchange carriers on
interexchange carriers to originate and terminate long distance calls
were reformed to more accurately reflect the low proportion of
switching costs that appear to be usage-sensitive (and the high
proportion that appear to be fixed), per-minute access charges
imposed on the long distance carriers would fall, but the fixed costs
of switching would likely be recovered by raising the subscriber line
charge imposed on end users for connecting to the network.
Consumer groups have consistently opposed line charges of any sort,
arguing that such charges unfairly burden low usage and low income
cust om ers.¹⁶
^!The access charges that long distance carriers must pay to small rural
local exchange carriers for originating or terminating the long
distance calls of the rural carriers’ customers tend to be higher than
the access charges paid to urban carriers. This is in part because the
small rural carriers’ underlying costs are higher than those of urban
carriers due to the lack of population density and lack of scale
economies and in part due to efforts by regulators to keep rural end

¹⁵ The intercarrier compensation rules are different for intraMTA wireless calls that
originate and terminate within an MTA and interMTA wireless calls that originate and
terminate in different MTAs.
¹⁶ See, for example, “Jessica Zufolo: Emerging VoIP Policy is Driving Investment,”
Telecom Policy Report, September 29, 2004.

users’ local rates low. Also, the rural carriers’ local calling areas
tend to be narrowly defined and to serve only a small number of
households. Many of their customers’ incoming and outgoing calls
therefore are classified as toll (long distance) calls, for which the
rural LECs receive above-cost minute-of-use access charges from
long distance carriers, rather than the fixed end-user charge typical
of local service. As a result, the small rural LECs historically have
generated a much larger portion of their total revenues from access
charges than have urban LECs.¹⁷ Since the access charges of rural
LECs exceed costs by more than those of urban LECs, and since
rural LECs have depended on access charges more than urban LECs,
reforming access charges to bring them down to cost would place a
greater revenue burden on rural LECs than on urban LECs. Absent
another revenue source, end-user line charges would have to be
raised more in rural areas than in urban areas. To keep line charges
from growing to the point where local service becomes unaffordable
or non-comparable with urban rates, a new universal service funding
mechanism would be needed to replace the implicit universal service
funding currently in the rural carriers’ access charges. Although all
the proposals for intercarrier compensation reform have included
new universal service funding mechanisms, the rural LECs prefer
not to have to rely so heavily on an explicit universal service funding
mechanism. They generally prefer to have three revenue sources —
line charges, universal service funds, and above-cost access charges
— rather than just the first two. In part, this is because they prefer
to recover a larger portion of their costs from long distance carriers
(whose averaged rates subsidize rural customers) than from their
own end-user customers in subscriber line charges. And in part it is
because they are concerned about relying too heavily on universal
service funds, which they consider a potentially unstable source of
revenue, especially now that rural wireless carriers are seeking these
same universal service funds.
^!Although section 254(e) of the 1996 Act requires universal service
support to be explicit and sufficient,¹⁸ many state regulators continue
to set intrastate access charges — and especially the intrastate access
charges of rural carriers — at above-cost rates that exceed interstate
access charges, in order to create a revenue source (ultimately borne
primarily by customers of long distance carriers that do not live in
rural areas) that will help keep local rates low. Some parties
question whether the FCC has the authority to modify intrastate

¹⁷ The ICC FNPRM, at paragraph 107, states: “According to NTCA [the National
Telecommunications Cooperative Association], rural LECs receive on average 10 percent
of their revenue from interstate access charges and 16 percent from intrastate access charges.
In comparison, it asserts that the BOCs [Bell Operating Companies] receive only four
percent of their revenue from interstate access charges and six percent from intrastate access
charges.”
¹⁸ The 1996 Act states at § 254(e): “Any such support should be explicit and sufficient to
achieve the purposes of this section.”

access charges (as part of comprehensive intercarrier compensation
reform) without the formal involvement of the states.
Given the many affected interests with conflicting views and the impact of
intercarrier compensation on so many public policy objectives, Congress could
consider oversight or legislation to provide the FCC with guidance as that proceeding
evolves. The purpose of this report is to provide a primer on intercarrier
compensation.
Historical Background
In a “network industry” such as telecommunications, customers benefit the more
people (or companies or websites or databases) they can reach over the network to
which they subscribe. Thus, if there is more than one network, consumer benefit is^th
maximized when those networks are interconnected. For most of the 20 century,
telephone service was provided by government sanctioned monopoly. When public
policy changed and competitive provision of service was permitted, the incumbent
providers were required to allow the new entrants to interconnect with their networks
in a nondiscriminatory fashion to complete calls made to the incumbents’ customers.
Otherwise, the incumbents could have used their dominant position to refuse to
interconnect with the smaller networks of the new entrants, or to impose onerous
interconnection terms and conditions on the entrants, and the latter would have been
impeded in their ability to attract and serve customers.
Today, most electronic communications require the use of more than one
carrier’s network to be completed. For example:
^!local wireline telephone calls originate on the network of the calling
party’s local exchange carrier and terminate on the network of the
called party’s local exchange carrier (which may be a competing
local exchange carrier or an adjacent local exchange carrier rather
than the caller’s local exchange carrier) or the called party’s cellular
carrier.
^!long distance calls originate on the network of the calling party’s
local exchange carrier, pass to the network of the calling party’s long
distance carrier, and then terminate on the network of the called
party’s local exchange carrier.
^!wireless telephone calls originate on the network of the calling
party’s wireless carrier, are transported over wirelines (typically
leased by the wireless carrier from a wireline carrier),¹⁹ and then
terminate on the network of the called party’s local exchange carrier
or wireless carrier.

¹⁹ More than 90% of wireless telephone calls travel over wireline facilities during some
portion of their route. Even most calls that originate and terminate on wireless networks
travel over wireline facilities at some point in their route.

^!end-user connections (dial-up or broadband) to information service
providers originate on the network of the subscriber’s (calling
party’s) local exchange carrier or broadband provider (wireline,
wireless, or cable), may be transported over an intermediate carrier’s
(transit) network, and terminate on the network of the carrier serving
the ISP (the called party).²⁰
While sometimes the calling party and called party have the same local or
wireless carrier, or sometimes the calling party purchases its local and long distance
service from the same carrier, in most cases completion of a call requires the use of
more than one carrier’s network.
The calling party only pays the local, long distance, or wireless carrier to which
it subscribes; it makes no payments to the called party’s carrier. And today only in
the case of wireless service does the called party pay anything to its carrier for calls
received. As a result, a system is needed to compensate the other carriers whose
networks are used to complete the call.
Prior to MCI’s successful legal challenge to the old Bell system’s government
sanctioned telephone monopoly²¹ and the consent decree settlement of the federal
government’s antitrust suit that resulted in the divestiture of AT&T into separate and
independent local and long distance companies,²² there was very limited need for
intercarrier compensation since there were very few carriers — only monopoly Bell
local operating companies, monopoly independent telephone companies, and AT&T
(the monopoly Bell long distance company that served both Bell and non-Bell
customers). Local service rates were kept low, to foster the goal of universal service,
by setting long distance rates far above cost. Sometimes, when an independent
telephone company bordered a Bell company service area, “extended area (local)
service” (“EAS”) was offered in which a local calling area extended beyond the
boundary of the independent telephone company into the Bell service area. EAS
service was intended to lower rates to subscribers by allowing calls that otherwise
would have been high priced long distance calls to be treated as local calls. When
the Bell operating companies terminated EAS calls originating on the independent
telephone companies’ networks, and vice versa, the companies did not charge one
another for such termination, even if the traffic between the two carriers was not in
balance. Rather, intercarrier compensation followed a system known as “bill-and-

²⁰ When the ISP receives the communication from a subscriber, it routes that
communication over its owned or leased distribution facilities (Internet transport networks)
or over a larger ISP’s transport network to a Network Access Point, where the
communication is routed to another Internet network and may travel over various Internet
backbone networks and regional or mid-level networks (which are connected by network
access points) and local area networks to reach the appropriate destination host.
²¹ MCI brought several suits against AT&T and also challenged in the courts several FCC
decisions. See, for example, MCI Telecommunications Corporation v. Federal
Communication Commission, 561 F. 2d 365 (D.D.Cir. 1977).
²² Modification of Final Judgment, United States v. American Telephone and Telegraph
Company, 552 F. Supp 131 (D.D.C. 1982).

keep,” in which no payments were made from one carrier to the other, as if traffic
were in balance. With respect to compensation from the long distance division of
AT&T to the independent telephone companies for originating and terminating long
distance calls, these charges were set based on a complex system of cost
“separations” and “settlements” that resulted in the AT&T long distance carrier
paying intercarrier compensation rates that far exceeded cost in order to subsidize
local service. In the internal accounts of the Bell System, too, payments were made
from the long distance division to the various local Bell operating companies that
resulted in the AT&T long distance carrier paying origination and termination rates
that far exceeded cost.
As competitive provision of telecommunications services has been allowed in
a piecemeal fashion over the past 30 years, state and federal regulators have regulated
the newly necessary intercarrier compensation rates also on a piecemeal basis,
allowing or requiring very high or very low rates in order to foster specific public
policy objectives rather than requiring intercarrier compensation rates to be set
consistently for all calls. As shown in Figure 1, the resulting rates for performing the
same termination functions (transport and switching) vary significantly simply
because a particular call is interstate vs. intrastate, or because a service provider has
been treated as an end user rather than a carrier, or because a call terminates on a
wireless network rather than a wireline network. For example:
^!in order to maintain low rates for basic local service — to help meet
the goal of universal service — state regulatory commissions and the
FCC have allowed local exchange carriers to charge long distance
carriers significantly above- cost access charges for originating and
terminating intrastate and interstate long distance calls. Although
the 1996 Act requires the creation of explicit universal service
funding mechanisms,²³ and the FCC has established a transition
process that has lowered interstate access charges closer to cost,²⁴
some implicit universal service subsidies remain in certain
intercarrier compensation charges, especially in rural LECs’
intrastate access charges that, as shown in Figure 1, average more
than five cents per minute.
^!in order to promote enhanced services, the FCC has treated enhanced
service providers (including ISPs) as end users, rather than carriers.
This allows ISPs to purchase lines out of the local carriers’ tariffs for
business customers, which do not include usage-based charges,
rather than out of the tariffs for interexchange carriers, which have
usage-based charges for both originating and terminating calls.

²³ The 1996 Act states at § 254(e): “Any such support should be explicit and sufficient to
achieve the purposes of this section.”
²⁴ See, for example, Access Charge Reform, Price Cap Performance Review for Local
Exchange Carriers, CC Docket Nos. 96-262 and 94-1, Sixth Report and Order, Low-
Volume Long Distance Users, CC Docket No. 99-249, Report and Order, Federal-State
Joint Board on Universal Service, CC Docket No. 96-45, Eleventh Report and Order, 15
FCC Rcd 12962, 12991-93, paras. 76-79 (2000).

Since ISP customers often stay online for long periods of time, if
ISPs had to pay minute-of-use access rates it would have made it
prohibitively expensive to offer flat rated retail service.
^!the FCC adopted rules²⁵ to implement statutory language in the 1996
Act requiring reciprocal compensation arrangements for the
transport and termination of telecommunications between competing
local exchange carriers at rates approximating the “additional costs”
of performing those functions.²⁶ These rules covered the local calls
of local exchange carriers and the intraMTA calls of CMRS
(wireless) carriers.
^!since wireless service in the past was seen as a niche service whose
customers made a lot of calls but received very few, and not as a
substitute for long distance wireline service, wireless providers are
required to pay wireline local exchange carriers access charges for
the termination of interMTA calls originating on their networks and
terminating on wireline networks, but are not allowed to charge
other carriers access charges for the termination of interMTA calls
received by their subscribers.
These, and other, inconsistencies in intercarrier compensation requirements are
incompatible with competitive telecommunications markets.
Comprehensive Intercarrier Compensation Reform:
Key Issues
The current intercarrier compensation rules developed in a piecemeal basis as
alternative providers, some using new technologies, were granted permission to
compete with existing providers and interconnect with the incumbents’ networks.
In each case, explicit or implicit decisions were made about, among other things,
where and how the interconnections could occur, what the terms, conditions, and
rates were for the interconnection, and who should bear the transport and switching
costs associated with terminating (and, in the case of long distance service,
originating) the traffic. A decision to modify one of these parameters is likely to
affect the others. For example, changing the requirements about where carriers may
or must interconnect for the exchange of traffic may affect the portion of the cost
burden that each carrier should bear and/or the most efficient pricing mechanism for
intercarrier compensation. In the debate over alternative intercarrier compensation
reform proposals, a number of important — and contentious — issues are likely to
be raised.
Should the called party share the cost burden with the calling
party?

²⁵ 47 C.F.R. § 51.701.
²⁶ 1996 Act, §§ 251(b)(5), 252(d)(1)(A), and 252(d)(2)(A).

Why this matters.
Most telephone calls and electronic communications benefit both the calling
party and the called party, so there could be justification for the calling party and the
called party sharing in the cost of the call. But in the United States traditionally only
the calling party (and the carrier to which that party subscribes) has paid.²⁷ The FCC
refers to this as the “calling-party-network-pays” approach to intercarrier
compensation.²⁸ This approach has been justified on several grounds:
^!called parties should not have to pay for unwanted and unsolicited
calls, such as those from commercial or noncommercial
telemarketers and spammers.
^!customers should be able to control their monthly local telephone
bill, which is more difficult to achieve if they must pay for incoming
calls that, unlike outgoing calls, are beyond their control.
^!the administrative costs may be higher if the carrier of the calling
party and the carrier of the called party each have to bill an end-user
customer, rather than just the carrier of the calling party billing its
end-user customer and, in turn, the carrier of the called party billing
the carrier of the calling party.
But the primary reason why policy makers have preferred a calling-party-network-
pays regime is that it allows them to set intercarrier compensation rules that foster
such public policy objectives as universal services and the protection of nascent
services such as Internet services.
For example, under a system of calling-party-network-pays, the costs of
terminating a call are borne by the calling party’s carrier — and, as will be discussed
below, it is possible to set terminating rates that exceed those costs. In particular,
above cost termination rates can be imposed on long distance carriers, and the extra
revenues from those above cost termination rates can be used to keep end users’ local
rates low. The long distance carriers, in turn, will impose most of the burden of those
above cost termination rates on low cost urban customers. Since long distance
carriers are required to set nationally averaged retail long distance rates,²⁹ the low
cost urban customers will be subsidizing the higher cost rural customers. These
above-cost rates for terminating calls, however, create market distortions that may
give some providers artificial competitive advantages over other providers.

²⁷ However, as explained in the Historical Background section, prior to the break-up of the
Bell System, extended area local service traffic flowing between the Bell local companies
and independent telephone companies was exchanged on a bill-and-keep basis, in which the
carriers were not compensated for completing calls for one another. (Some Bell operating
companies and independent LECs still employ bill-and-keep.) The carriers recovered the
costs of terminating these local calls from their own customers — that is, the called party
shared the cost.
²⁸ ICC FNPRM, at p. 10, para. 17.
²⁹ See footnotes 5 and 6 above.

In contrast, if the costs of terminating calls are borne by the called party — that
is, the end user pays its local carrier for the terminating costs associated with received
calls — there is no potential intercarrier source of subsidies. The called party’s local
service rate would recover those terminating costs, either through an additional line
item on the bill or an increase in an existing line item. If the resulting line item(s) are
determined by a regulatory body to be unaffordable or non-comparable to urban rates,
and thus set at a price below costs, the called party’s LEC might receive explicit
universal service funding or implicit subsidies from above cost business rates or rates
averaged across high cost and low cost customers, but would no longer be able to
receive subsidies from other carriers.
Analysis and discussion.
In a normal market, if a provider sets price well above cost, that creates a market
incentive for its customers to seek an alternate provider and for other providers to
enter the market. But under calling-party-network-pays, there are no built in market
forces constraining the price a carrier could charge another carrier for terminating
calls.
Consider the simple example, shown in Figure 2, of end user A, who subscribes
to LEC Y for local service, making a local call to end user B, who subscribes to LEC
Z for local service. Completion of the call requires use of both Y’s network and Z’s
network, but only Y gets paid by the calling party. The call goes over the line from
end user A’s residence to the end office in LEC Y’s network that serves A. It is
routed through the switch in that end office to the transport line that goes to the point
of interconnection (“POI”) or “meet point” between LEC Y’s network and LEC Z’s
network. The call is then transported over LEC Z’s network to the end office in Z’s
network that serves end user B. In that end office, it is switched to the residential line
that goes to B’s house. Since Z is providing necessary transport and switching
functions that its own subscriber B does not pay for, in a calling-party-network-pays
regime it will demand compensation from Y for terminating the call. But if Z sets
the price it charges Y for terminating the call well above cost, this does not raise the
cost for the called party, B, who is not charged for termination. It simply adds to the
cost of Y. The latter is a captive customer since it cannot affect B’s choice of local
exchange carrier. Once B has chosen Z to be its LEC, Y has no actual or potential
alternative to Z for terminating that call. Absent regulatory intervention, the
terminating carrier — in this case, Z — has the ability to exercise its market power
to raise the rates it charges other carriers, such as Y, for terminating calls made by
their subscribers.

Figure 2. Simple Telephone Call Over Two Carriers’ Networks
Source: Simplified version of a diagram presented in the ICF Plan at Appendix C,
p. 5.
Even if there are many competing local exchange carriers offering service to A
and B, once B has chosen its local exchange carrier, all calls to B must be terminated
over the network of that chosen carrier. B has no incentive to choose its local
exchange carrier based on which carrier charges the lowest rates to other carriers for
terminating calls to customer B. In fact, B might have the incentive to choose the
local exchange carrier that strategically charges very high rates to carriers for
terminating calls (since these customers are captive) and uses the extra revenue to set
lower rates for end-user customers.
Under calling-party-network-pays, there is one situation in which market forces
might constrain how much the called party’s carrier will charge to terminate the call.
If all carriers’ traffic tended to be in balance — in the sense that the number of calls
made by their customers (calling parties) to the customers of other carriers was
approximately the same as the number of calls received by their customers (called
parties) from the customers of other carriers — then the potential revenues and costs³⁰
from the function of terminating one another’s calls would tend to be a wash. The
incentive to raise the price for terminating calls would likely be constrained because
all carriers would face the same market environment in which higher revenues from
high termination charges imposed on other carriers would simply be matched by³¹

higher costs for high termination charges imposed by other carriers.
³⁰ Balanced traffic need not result in balanced costs if, for example, one of the carriers
faced a higher underlying cost structure (due, for example, to low population density or
unique terrain problems).
³¹ Carriers, however, could have an incentive to raise termination rates — even if they
would be matched by an equal increase in termination costs — if Wall Street values revenue
growth rather than (or in addition to) income growth. This condition holds whenever
“growth companies” are in ascendancy in the capital markets, as they were in the late 1990s.

But the traffic between carriers is rarely in balance and, as a result, there are no
market forces under a calling-party-network-pays pricing regime to constrain
termination charges. Indeed, local exchange carriers have the incentive to
strategically pursue those customers who receive more calls than they make — for
example, ISPs — because then they can take advantage of the fact that the calling
party’s carrier is a captive customer for terminating service to set rates for
termination far above cost with no risk of losing that captive customer.³² A local
exchange carrier whose customers receive more calls than they make will profit
because it will generate more revenues from terminating calls to its customers that
originate on other carriers’ networks than it will generate costs to terminate the calls
originated by its customers to called parties that subscribe to other carriers.³³ Several
small competitive local exchange carriers pursued this strategy to the point where
they allegedly provided local service to ISPs at little or no charge, obtaining most or
all of their revenues from the charges they made to other carriers for terminating
calls.³⁴ The ISPs do not pay for, and will not care about, the charges for terminating
service — and might even encourage their local carriers to charge carriers a higher
termination price if they can use that to negotiate a lower price for themselves.
Similarly, long distance carriers must make payments to local exchange carriers
both to connect to their customers and to complete the calls made by their customers,
but do not receive compensation from other carriers. Long distance customers will
not care about the rates that their local carriers charge long distance carriers to
complete calls to them; long distance carriers have no way to reward those customers
who call parties that choose local carriers with low termination charges.³⁵ In a

³² See In the Matter of Implementation of the Local Competition Provisions in the
Telecommunications Act of 1996 and Intercarrier Compensation for ISP-Bound Traffic, CC
Docket Nos. 96-98 and 99-68, Order on Remand and Report and Order (“2001 ISP Order”),
adopted April 18, 2001 and released April 27, 2001, at paragraph 5, which states: “For
example, comments in the record indicate that competitive local exchange carriers (CLECs),
on average, terminate eighteen times more traffic than they originate, resulting in annual
CLEC reciprocal compensation billings of approximately two billion dollars, ninety percent
of which is for ISP-bound traffic. Moreover, the traffic imbalances for some competitive
carriers are in fact much greater, with several carriers terminating more than forty times
more traffic than they originate.” (Footnotes omitted.) In some situations, CLECs enjoyed
an advantage over ILECs when competing for these customers because they had complete
flexibility in the pricing they could offer while ILECs were subject to regulatory constraints
limiting them to sales out of their published tariffs and prohibiting the use of customer-
specific contracts.
³³ This is especially so if a CLEC can identify just a single point of interconnection in a
large geographic area and the ILEC must bear all the costs of transporting traffic originating
on its network to that single POI, which is allowed under the current rule.
³⁴ See 2001 ISP Order, at para. 5, where the FCC found that “under the current carrier-to-
carrier recovery mechanism, it is conceivable that a carrier could serve an ISP free of charge
and recover all of its costs from originating carriers.”
³⁵ Long distance carriers are in a somewhat less captive position with respect to the
originating portion of calls than the termination portion of calls. When a long distance
carrier has a very large customer that originates many calls, if that customer’s local
exchange carrier sets the charges for originating long distance calls far above cost, it may
(continued...)

calling-party-network-pays regime, there are no market forces constraining the price
of terminating long distance calls.
As a result, even as competition has developed in many telecommunications
markets, allowing regulators to reduce or eliminate their regulation of prices, there
is general agreement that under a calling-party-network-pays regime regulation is still
needed for intercarrier compensation rates charged for terminating communications
on the local telephone network.
But that regulation typically has not taken the form of requiring carriers to pay
cost-based termination rates. Rather, it has given regulators the latitude to set
intercarrier compensation rates that foster certain public policy goals. As discussed
earlier, both interstate and intrastate access charges historically have been set to far
exceed cost, especially for rural carriers and intrastate calls, as a means of
maintaining low basic local service rates. Similarly, ISPs have been deemed end
users specifically to allow them to avoid intercarrier compensation charges.
But this market failure rationale for government intervention in the market to
set intercarrier compensation rates may disappear under a regime of called-party-
shares. If the called party (rather than the calling party or the carrier to which the
calling party subscribes) were responsible for compensating its local exchange carrier
for terminating the call, then that called party would have the incentive to choose a
local exchange carrier whose termination charges are low. If a carrier set termination
rates that far exceeded cost, its subscribers would have the incentive to seek out an
alternative carrier. Of course, this market correction could only occur where end
users had real competitive alternatives to turn to if their current local carriers raised
rates. It is likely, however, that regulation of end-user termination charges will
continue until such effective competition develops.
Several of the proposals for comprehensive intercarrier compensation reform,
as well as the FCC staff proposal, question whether the advantages of calling-party-
network-pays still hold and argue that it introduces inefficiencies and distortions that

³⁵ (...continued)
induce the long distance carrier or a competitive access provider to put in a dedicated line
between the customer’s premise and the long distance carrier’s network to carry those calls,
thereby avoiding the local exchange carrier’s originating access charges. And even for
smaller customers, if there are competing local exchange carriers and one of those carriers
seeks to charge long distance carriers a very high price for originating access, long distance
companies could charge their customers a higher price if they chose the local exchange
carrier with high origination access charges. This might entice some customers to switch
to a local carrier that has lower rates for originating access — and thus would place market
pressure on the local carrier with high originating access rates to lower those rates. In
practice, however, this ability of the market to impose price discipline is limited for two
reasons: (1) the FCC rules implementing the requirement in section 254(g) of the 1996 Act
that long distance carriers set rates in rural areas that are no higher than rates in urban areas,
and that rates not vary across states, effectively requires long distance carriers to set
nationwide averaged rates, and (2) the administrative costs of varying end user long distance
rates based on the individual customer’s choice of local exchange carrier may exceed the
combination of higher revenues from the higher charges and the costs savings from those
end users that actually switch to a LEC that has lower originating access charges.

are inconsistent with competitive markets. First, they argue that under calling-party-
network-pays, it is necessary for regulators to set rates for intercarrier compensation,
which will always be a contentious and expensive process. Second, they claim that
today there are ways for customers to manage their incoming calls — screening
services such as caller ID, IP-enabled services that enable customers to determine
how and when they will receive calls, do not call registries — to minimize the receipt
of calls from which they do not benefit. Third, they claim that most costs associated
with terminating calls are not usage-sensitive and therefore termination costs should
be recovered through a fixed line charge, not a per-minute-of-use charge. Thus,
although the line charge an end user pays would initially increase under a called-
party-shares plan, that line charge would not fluctuate with the number of calls
received and end users could control their monthly telephone bill. Fourth,
administrative costs would not increase if the charge were simply a line charge; the
subscriber line charge on each customer’s bill might change, but all customers
already receive bills with monthly line charges. Fifth, in the 1996 Act, Congress
instructed the FCC to remove implicit universal service subsidies from rates and
place them in an explicit funding mechanism.³⁶ A called-party-shares approach
would facilitate that.
But there are several counter-arguments. First, the available means for
customers to manage their incoming calls have associated costs, which (especially
when added to a higher subscriber line charge) may be burdensome for low income
customers. Second, if all the termination costs are placed on the called party, there
is no market disincentive for high volume callers, such as telemarketers and
spammers, to increase their usage. As will be discussed later, increased calling
volume will increase switching costs during peak periods.
The advantages and disadvantages of a calling-party-network-pays approach vs.
a called-party-shares approach will depend on a number of factors, including where
interconnection is allowed or required, the underlying cost structure for
interconnection and termination, the extent to which termination costs vary across
networks, and how easy it is to identify the underlying network cost structure and
measure actual costs.³⁷ To the extent these parameters vary with the specific
interconnecting networks (for example, do some networks have more usage-sensitive
costs than others? is it more efficient for some networks than for others to have
multiple interconnection points?), it may be optimal to implement a hybrid
intercarrier compensation system. But if a hybrid system is implemented, it will be
necessary to ensure that it does not artificially favor one set of providers over another
in a competitive market.
Where should networks be allowed, or required, to
interconnect with one another?
Why this matters.

³⁶ 47 U.S.C. § 254(e).
³⁷ These issues are addressed in the sections that follow.

Whether the cost burden of completing calls is borne entirely by the calling
party’s carrier or shared with the called party, the cost of the terminating (or
originating) portion of the call will depend on where the carriers are allowed or
required to interconnect. Where two carriers’ networks are alike, using similar
technologies and configured to serve similar customer bases, such similarities might
allow them to identify an agreed upon single interconnection point, or set of points,
that does not place either carrier at a relative advantage/disadvantage. But the
network architectures of the various carriers vary dramatically for a number of
reasons: historical (the ILECs were required to build out ubiquitous networks that
others need not replicate), technological (some technologies maximize efficiency
with greater deployment of switches and smaller connecting transport “pipes” while
others are optimized with the use of fewer, larger switches connected by higher
capacity transport pipes), geographic (optimal network architecture will differ in
urban and rural areas or for carriers serving wide areas vs. those serving narrowly
defined areas). As a result, the optimal point(s) of interconnection may be very
different for different types of networks. Each carrier will want to set point(s) of
interconnection that favor its particular network configuration. If left entirely to
market negotiation, the incumbent LECs, who during the transition from monopoly
to competitive markets retain some market power, might be able to impose
interconnection terms and conditions that would undermine the efficiencies of the
entrants’ network architectures and technologies.³⁸
The principal situation where distinct network architectures have made it
difficult for carriers to reach agreement about where to interconnect and how to
structure intercarrier compensation involves the interconnection of ILEC and CLEC
networks.³⁹
Analysis and discussion.
Figure 2 shows a very simplified network architecture. The large ILECs, who
serve the vast majority of U.S. households and businesses, have extensive and
ubiquitous “hierarchical” networks, with a number of tandem switches that aggregate
and route traffic to a much larger number of end office switches serving particular
neighborhoods, all of which are connected by a very large web of transport facilities.
When such an ILEC terminates a call that originates on another carrier’s network, the
call typically will be routed through one or more of its tandem switches before
reaching the end office switch serving the called party. Other carriers (in particular,
the competitive local exchange carriers) use newer technologies and have less

³⁸ As explained earlier, as United States telecommunications policy has evolved from
government sanctioned monopoly provision to competitive provision of telecommunications
services, incumbent providers have been required to allow new entrants to interconnect with
their networks in a nondiscriminatory fashion. Otherwise, the incumbents could use their
dominant position to refuse to interconnect with the smaller networks or the new entrants,
or to impose onerous interconnection terms and conditions on the entrants.
³⁹ There also has been a lot of disagreement between rural LECs and wireless carriers about
where and how to interconnect to exchange traffic. But since this disagreement typically
involves interconnection through an intermediate (transit) network of a third carrier, it is
discussed in a later section on rules for transit networks.

extensive, non-hierarchical networks, often with only a single switch serving a much
larger area — with that switch, in effect, providing the functions of both an end office
switch and a tandem switch.
Requiring the CLECs to build out their own networks to interconnect at or near
every ILEC end office switch (in every local calling area) — or even to interconnect
at or near every ILEC tandem switch — would in effect impose the ILEC network
architecture on the CLECs, even though the latter use different technologies and have
different business plans. What might be an efficient architecture for the ILECs might
not be so for the CLECs. Moreover, even a successful CLEC entrant is unlikely to
attain the penetration levels of the ILECs for many years and thus will not be able to
exploit the scale economies enjoyed by the ILECs; it is not feasible for them to
replicate the ILECs’ ubiquitous networks.
On the other hand, if the CLECs are only required to interconnect with the
ILECs at a single POI in a large geographic region, then ILECs would have to
transport traffic well beyond local calling area boundaries to be exchanged. This
could be very costly if ILECs bore the cost of transporting traffic originating on its
network to the single POI. Also, with a single POI traffic exchange will occur on
average further from both the calling party’s location and the called party’s location;
when either the calling party or the called party is an ILEC subscriber communicating
with a CLEC subscriber, that will result in greater congestion on the ILECs’
ubiquitous networks than with multiple POIs. In addition, if a called-party-shares
regime were implemented in conjunction with a single POI, more substantial charges
for termination might be imposed on the called party than would be the case if there
were many mandated points of interconnection.
The 1996 Act requires an ILEC to allow a requesting local telecommunications
carrier to interconnect at any technically feasible point.⁴⁰ The FCC has interpreted
this provision to mean that CLECs have the option to interconnect at a single POI per
“local access and transport area” (“LATA”).⁴¹ In general, LATAs are broader than
local calling areas, so an ILEC bringing traffic that originates on its network to a
single POI often would be required to transport that traffic outside the local calling
area. FCC rules preclude a local exchange carrier from charging other carriers for

⁴⁰ 47 U.S.C. § 251(c)(2)(B).
⁴¹ 15 FCC Rcd 18354, 18390, para. 78, n. 174 (2000). LATAs were created in the 1982
Modified Final Judgment court order breaking up the old Bell System. A LATA was the
geographic area in which Regional Bell Operating Companies could offer service. They
were prohibited from offering services that extended from a point in their service area to a
point beyond a LATA boundary. Such interLATA services were offered by interexchange
carriers. LATAs can cover very large geographic areas, even entire states. Today these
LATA restrictions no longer hold; all the Regional Bell Operating Companies are allowed
to offer interLATA service. But the interconnection rules continue to be based on the
LATA boundaries. The FCC rule allowing a CLEC to interconnect with an ILEC at a single
POI per LATA does not apply to interexchange (long distance) carriers interconnecting with
ILECs.

traffic that originates on the local exchange carrier’s network⁴² — that is, it cannot
charge another carrier for bringing the traffic to the single POI. At the same time,
under the 1996 Act, all LECs have the “duty to establish [cost-based] reciprocal
compensation arrangements for the transport and termination of [local]
telecommunications.”⁴³ The FCC rules implementing that provision permit a
terminating carrier to recover from the originating carrier the cost of certain facilities
from an “interconnecting point” to the called party.⁴⁴
In both its 2001 Notice of Proposed Rulemaking and its 2005 Further Notice of
Proposed Rulemaking, the FCC sought comment on whether an ILEC should be
obligated to bear its own costs of delivering traffic to a single POI when that POI is
located outside the local calling area.⁴⁵ The Commission has asked whether a carrier
should be required to interconnect in every local calling area or pay the incumbent
transport and/or access charges if the location of the single POI requires transport
beyond the local calling area.
Not surprisingly, in their comments, most CLECs and wireless carriers favor
maintaining a single POI per LATA rule⁴⁶ and the ILECs support a requirement that
competitive carriers establish a POI in each calling area or pay the transport costs to
reach a POI outside the local calling area.⁴⁷ The current rules may encourage traffic
imbalance because terminating networks not only collect reciprocal compensation,
they also avoid financial responsibility for the transport facilities needed to bring
traffic from the originating ILECs’ network all the way to the single POI.⁴⁸ When
traffic is out of balance, the cost of interconnection is borne primarily by the
originating carrier, and the terminating carrier may lack the incentive to minimize the
transport costs associated with connecting the two networks.
As providers from different segments of the industry have come together to
attempt to develop consensus positions on intercarrier compensation, compromise
positions have been proposed that take into account differences between the network
architectures of different carriers. For example, although the ICF Plan proposes a

⁴² 47 C.F.R. § 51.703(b).
⁴³ 47 U.S.C. § 251(b)(5).
⁴⁴ 47 C.F.R. § 51.701. The FCC rules permit recovery of the costs of transport and
termination of telecommunications traffic between local exchange carriers and other
telecommunications carriers. The rules define “transport” as the “transmission and any
necessary tandem switching of telecommunications traffic subject to section 251(b)(5) of
the act from the interconnection point between the two carriers to the terminating carrier’s
end office switch that directly serves the called party, or equivalent facility provided by a
carrier other than an incumbent LEC.” The rules define “termination” as the “switching of
telecommunications traffic at the terminating carrier’s end office switch, or equivalent
facility, and delivery of such traffic to the called party’s premises.”
⁴⁵ ICC NPRM at para. 113 and ICC FNPRM at paras. 87ff.
⁴⁶ ICC FNPRM at para. 89.
⁴⁷ Id. at para. 90.
⁴⁸ Id. at para. 91.

transition to unified intercarrier compensation rates, it explicitly identifies three types
of networks — hierarchical networks of the type deployed by the large ILECs, rural
networks operated by certain rural carriers, and non-hierarchical networks of the sort
deployed by some CLECs — and proposes different requirements and responsibilities
for the exchange of traffic for each.⁴⁹
The various reform proposals submitted demonstrate creative approaches to this
complex issue. For example, in the ICC FNPRM, the FCC raised an issue about the
interrelationship between network interconnection and intercarrier compensation
pricing: if the Commission were to adopt a bill-and-keep approach and competitors
had to pay the same rate (zero) to terminate calls wherever they connect to the ILEC
network, would there be any incentives for CLECs or wireless carriers to
interconnect at more than one point of interconnection per LATA — since to do so
would increase their network costs but not result in any savings in intercarrier
compensation costs?⁵⁰ But, as demonstrated by the ICF Plan, that concern could be
addressed by allowing each carrier to identify at least one point (per LATA) in its
network where it will receive traffic for routing within its network, and if the
originating carrier seeks to interconnect at a point different from the one chosen by
the terminating carrier, require the originating carrier to bear the cost burden for
transport between those points.⁵¹
What is the underlying cost structure of the transport and
switching functions?
Why this matters.
The rates for intercarrier compensation that carriers must pay become part of
their costs of providing service, and the rate structure of that compensation will affect
the carriers’ underlying cost structure. If those charges are usage-sensitive, then the
carriers’ underlying costs become usage-sensitive — and will make it more difficult
for those carriers to offer end users large baskets of minutes or unlimited calling at
a fixed price. That will be efficient if, indeed, the underlying transport and switching
costs associated with terminating (or originating) a call are in fact usage-sensitive.
In that situation, unlimited calling packages at a fixed price would encourage
inefficient overuse of the network facilities. On the other hand, if the underlying
costs of transporting and switching calls are not usage-sensitive, but the intercarrier
compensation charges are usage-based, then carriers could be artificially discouraged
from offering fixed price service that consumers seek and, indeed, could be punished
in the marketplace for providing a fixed price service offering that would make
efficient use of the public switched telephone network. Moreover, if not all carriers
are subject to the same intercarrier compensation regime, those that face intercarrier

⁴⁹ See the ICF Plan proposed by the Intercarrier Compensation Forum, submitted in In the
Matter of Developing a Unified Intercarrier Compensation Regime, Docket No. 01-92, on
October 5, 2004.
⁵⁰ ICC FNPRM at para. 96.
⁵¹ ICF Plan at Appendix A, pp. 4, 10-12. The ICF calls this “edge to edge interconnection
transport.”

rates that do not reflect underlying costs could be placed at an artificial competitive
disadvantage.
Analysis and discussion.
To terminate traffic by routing it from the POI to the called party requires the
use of transport and switching facilities. The underlying costs of transport facilities
are not usage-sensitive. Once a line between the POI and a tandem or end office
switch (or between a tandem and an end office switch, or between an end office
switch and an end user’s premises) has been put in place, its costs will not vary with
usage. Economists and regulators have long recognized that it is not efficient to
recover usage-insensitive costs through minute-of-use charges, because such charges
will discourage usage, which is not the cost causer. As a result, today the costs
associated with transport are almost always recovered through recurring fixed
monthly charges.⁵²
There has been much more debate on the extent to which switching costs are
usage-sensitive.⁵³ A number of carriers argue that a substantial majority of switching
costs do not vary with minutes of use.⁵⁴ The FCC became involved in this debate
when it was petitioned to stand in for the state of Virginia, which refused to arbitrate
interconnection agreement disputes between Verizon and two CLECs (AT&T and
MCI).⁵⁵ One of the disputed issues involved the underlying costs and appropriate rate
structure and rates for switching. Verizon asserted that several costs (the “getting
started” cost of a switch, equivalent POTS half call (“EPHC”) costs, and the right-to-
use (“RTU”) software costs) should be recovered on a minute-of-use basis. AT&T
and MCI disagreed. In its Memorandum and Order, the FCC concluded that (1) the

⁵² When long distance carriers make intercarrier compensation payments to their
subscribers’ local exchange carriers for use of those carriers’ networks to originate long
distance calls, there may be some usage-sensitive costs associated with the trunk ports at the
LEC’s switch. These are sometimes classified as transport costs and sometimes as
switching costs.
⁵³ More exactly, the debate has focused on end office switching. It is generally agreed that
the underlying cost structure of tandem switches is not usage-sensitive. Tandem switches
are usually viewed as part of the transport function, rather than part of the switching
function.
⁵⁴ For example, MCI has argued that vendor contracts for switching establish per-line
prices, rather than per-minute prices, and thus local exchange carriers do not incur switching
costs on a per-minute basis. And digital switches are being produced with such large
processor capacity that their costs may no longer vary with minutes of use. See ICC
FNPRM at paras. 23, 68.
⁵⁵ In the Matter of Petition of WorldCom, Inc. Pursuant to Section 252(e)(5) of the
Communications Act for Preemption of the Jurisdiction of the Virginia State Corporation
Commission Regarding Interconnection Disputes with Verizon Virginia Inc. and for
Expedited Arbitration, CC Docket No. 00-218, and In the Matter of Petition of AT&T
Communications of Virginia, Inc., Pursuant to Section 252(e)(5) of the Communications Act
for the Preemption of the Jurisdiction of the Virginia Corporation Commission Regarding
Interconnection Disputes with Verizon Virginia Inc., CC Docket No. 00-251, Memorandum
Opinion and Order (“FCC’s Virginia Arbitration Order”), adopted August 28, 2003, released
August 29, 2003.

end office “getting started” switch cost is a fixed cost, which does not vary with the
number of ports or the level of usage on the switch, and should be recovered on a
per-line port basis;⁵⁶ (2) the EPHC costs should be recovered on a per-line port
basis;⁵⁷ and, (3) the RTU fees should be recovered on a per-port basis for the same
reasons as the getting started costs.⁵⁸
Verizon, AT&T, and MCI did agree that certain switching costs are usage-
sensitive, and that those usage-sensitive costs only applied to usage during peak
periods.⁵⁹ But the parties disagreed on how those shared, peak period costs should
be recovered. All the parties agreed that it would not be feasible to impose peak
period usage charges. Verizon and AT&T argued these costs should be recovered
through minute-of-use charges across all time periods; MCI argued that these costs
should be recovered through a flat per-port charge.⁶⁰ The FCC concluded that, while
neither approach is ideal, the flat per-port charge is better because it would not place
any provider at a competitive disadvantage.⁶¹
Based on these conclusions, most of Verizon’s switching costs were deemed not
usage-sensitive and an even larger proportion of its switching costs were recovered
through port or line charges rather than minute-of-use charges.
However, this FCC conclusion may not fully resolve how switching costs
should be treated for intercarrier compensation. There is no specific statutory or
regulatory guideline for the costing methodology to use for determining intercarrier
compensation. In its Virginia arbitration decision, the FCC used the total element
long run incremental cost (“TELRIC”) methodology that it had adopted to determine
the costs and rates for unbundled network elements. TELRIC calculates the average
incremental cost of providing the entire demanded quantity of a network element.
By contrast, the statutory cost standard for reciprocal compensation (the intercarrier
compensation associated with completion of local calls) is “additional cost,”⁶² which
only looks at the additional incremental quantity of the element needed for
terminating (or originating) traffic. It is possible that some costs that are not usage-
sensitive when viewed from the perspective of the entire quantity of switching
demanded would be usage-sensitive from the perspective of a smaller increment of
switching usage. However, the FCC has concluded that the reciprocal compensation
requirements (and hence “additional cost” methodology) in the 1996 Act only apply
to local telecommunications traffic and not to access charges.⁶³

⁵⁶ FCC’s Virginia Arbitration Order at para. 463.
⁵⁷ Id. at para. 471.
⁵⁸ Id. at para. 472.
⁵⁹ Id. at para. 473.
⁶⁰ Id. at para. 474.
⁶¹ Id. at paras. 475-477.
⁶² 47 U.S.C. § 252(d)(2)((A)(ii).
⁶³ In the Matter of Implementation of the Local Competition Provisions in the
(continued...)

It appears, then, that a significant proportion of the switching costs associated
with terminating a call are not usage-sensitive, but there is no consensus on exactly
what that proportion is.
Properly identifying the underlying cost structure for switching has four
important policy consequences.
First, if the preponderance of switching costs are not usage-sensitive, then the
current recovery of most switching costs in per-minute-of-use access charges and
reciprocal compensation charges is creating market signals that do not reflect
underlying costs. It would be more efficient to recover those switching costs through
a fixed line charge that sends a market signal reflecting that it is the additional
switching capacity needed to serve additional lines, rather than the additional
switching capacity needed to serve increased usage, that is driving switching costs.
If this is correct, any per-minute-of-use charge to recover usage-sensitive costs
should be quite small.
Second, if the underlying cost structure for transporting and terminating calls
is indeed overwhelmingly line-driven, rather than usage-driven, so that the bulk of
the costs are caused by the called party hooking up to the network, rather than by
usage of the terminating carrier’s switch to terminate calls, then this might argue for
employing a called-party-shares approach to intercarrier compensation, rather than
a per-minute-of-use charge on the calling party’s carrier. Such a charge would likely
take the form of an increase in the end-user subscriber line charge.
Third, if the proportion of termination costs that are usage-sensitive costs is very
small, then even if the interconnecting carriers’ traffic and costs are not in exact
balance, the distortion from employing bill-and-keep — that is, setting a zero per
minute-of-use charge for termination and recovering all costs through end-user
subscriber line charges — would be minuscule. In contrast, if a significant
proportion of the switching costs associated with transporting and terminating traffic
is usage- sensitive, so that significant minute-of-use charges would most closely
reflect underlying costs, then a bill-and-keep system, which effectively sets a zero
price for termination, would create a distorting market signal that the switch usage
for termination is costless. Providers might have the incentive to aggressively pursue
customers that make more calls than they receive — for example, telemarketers —
because if their traffic were imbalanced toward origination they could generate
revenues from subscribers without incurring the costs associated with terminating the
large volume of calls made by their subscribers.
Fourth, setting intercarrier compensation rates and rate structure in a fashion that
does not reflect underlying costs can have a significant competitive impact. For
example, under the current access charge regime, interexchange carriers are charged
on a per-minute-of-use basis for the switching used to originate and terminate their

⁶³ (...continued)
Telecommunications Act of 1996, First Report and Order, CC Docket Nos. 96-98 and 95-

185, 11 FCC Rcd 15499, 16013 (1996).

customers’ calls, making the interexchange carriers’ underlying cost structure usage-
sensitive even though the preponderance of those switching costs appear not to be
usage-sensitive. But by facing these artificially imposed usage-based costs, long
distance carriers are discouraged from offering large baskets of minutes or unlimited
calling at a fixed price since they would lose money when serving high usage
customers, who are the customers most likely to select such packages. The long
distance carriers assert that the Bell operating companies, which are now allowed to
offer long distance service and typically do so as part of a package of local and long
distance service, do not face the same problem. The long distance carriers claim that,
even if the Bell companies’ long distance arms must pay the same usage-based access
charges to their local operating companies as the long distance carriers pay, the
underlying costs to the Bells are not usage-sensitive. That is, any losses that the
Bells’ long distance arms might suffer, when serving a high usage customer, by
having to pay minute-of-use access charges while offering large baskets of minutes
or unlimited calling at a fixed price, are matched by the additional profits that the
Bells’ local operating companies generate from those minute-of-use access charges
(since their underlying costs are not increasing with usage).
What system is needed for setting intercarrier compensation
rates for intermediate (transit) networks?
Why this matters.
More and more networks need to interconnect with one another to complete
calls. But in many cases the volume of traffic exchanged between two carriers is not
sufficient to justify deployment of dedicated facilities for that exchange. Other
carriers, especially ILECs, may already have facilities that interconnect with each of
the carriers and that can carry the traffic between the carriers. Presently, there are no
rules pertaining to intercarrier compensation of those intermediate (transit) networks.
Analysis and discussion.
Transiting occurs when two carriers that are not directly interconnected
exchange traffic by routing the traffic through an intermediary carrier’s network.⁶⁴
Transiting can involve local traffic or long distance traffic. Neither the calling party
nor the called party subscribes to the transit carrier, and thus in either a calling-party-
carrier-pays system or a called-party-shares system there must be a mechanism for
compensating any transiting carrier used to complete a call.
Frequently, a CLEC or wireless carrier in a local market will not interconnect
with all other CLECs or wireless carriers in that market because it does not exchange
sufficient traffic with many of the carriers to justify the investment in facilities.
Rather, it will route traffic bound to another CLEC or wireless carrier through its own
POI with the ILEC, over the ILEC’s tandem switch and transport network to the other
CLEC’s (or wireless carrier’s) POI with the ILEC. This is feasible because all
CLECs and wireless carriers will be interconnected to the ILEC’s network.

⁶⁴ Much of the discussion in this section comes from the detailed presentation in the FCC’s
ICC FNPRM, at paras. 120-133.

Also, almost all wireless calls are carried on intermediate wireline facilities
before reaching their final destination. The wireless carriers often lease these lines
from long distance carriers, but (especially in rural areas where the volume of traffic
does not justify leasing a line) the wireless traffic sometimes will be routed directly
over the long distance carrier’s network (or over the network of a large ILEC located
adjacent to the rural LEC) to reach the end user’s local exchange.
In each of these situations, the intermediary carrier charges a fee for use of its
facilities, but the current rules concerning traffic transiting over an intermediate
network differ when the traffic is local or long distance.
Transiting of long distance traffic is governed by the interstate and intrastate
access rules, under which access rates are set in tariffs. In contrast, although many
ILECs currently provide transit of local traffic pursuant to interconnection
agreements, the FCC has not determined whether carriers have a duty to provide such
transit service. The reciprocal compensation provisions of the act address the
exchange of traffic between an originating carrier and a terminating carrier, but the
FCC’s reciprocal compensation rules do not directly address how intercarrier
compensation should be paid to the transit service provider.
ILECs argue that they are not required to provide transit service under the 1996
Act and that transit service offerings should remain voluntary.⁶⁵ They explain that
they limit the availability of such services in order to prevent traffic congestion and
exhaust of tandem switch capacity, and to encourage carriers to establish direct
interconnection when traffic volumes warrant it. ILECs state that transiting should
be treated as an unregulated service offered at market-based prices or, alternatively,
at tariffed “special access” rates that are not cost-based.
CLECs and wireless carriers, on the other hand, argue that ILECs are required
to provide transit service under the act.⁶⁶ They explain that indirect interconnection
via a transit service provider is the most efficient means of interconnection and that
the availability of transiting is critical to the development of competition. Wireless
carriers in particular argue that the low volume of traffic exchanged with smaller
local exchange carriers does not warrant direct interconnection and that transit
service is necessary for indirect interconnection. CLECs and wireless carriers state
the FCC should set cost-based compensation rates for transit service.
The FCC has determined that the availability of local transit service is
increasingly critical to establishing indirect interconnection — a form of
interconnection explicitly recognized and supported by the act⁶⁷ — and may provide
the only efficient means by which to route traffic between the networks of CLECs,
wireless carriers, and rural LECs.⁶⁸ It also has determined that indirect
interconnection via a transit service provider is an efficient way to interconnect when

⁶⁵ ICC FNPRM at para. 122.
⁶⁶ Id. at para. 123.
⁶⁷ See 47 U.S.C. § 251(a)(1).
⁶⁸ ICC FNPRM at para. 125.

carriers do not exchange significant amounts of traffic.⁶⁹ But the FCC seeks
comment on its legal authority to impose transiting obligations. The FCC also seeks
empirical evidence about whether transit service is currently available at reasonable
rates, terms, and conditions, to help it determine whether there is a need for it to
require and regulate the provision of transit service (contingent on it having authority
to do so).⁷⁰
Many rural LECs argue that intraMTA⁷¹ traffic between a wireless carrier and
a rural LEC must be routed through an interexchange carrier and therefore should be
subject to access charges, rather than reciprocal compensation, even though it never
crosses an MTA boundary.⁷² On the other hand, wireless carriers argue that calls that
originate and terminate within a single MTA are subject to reciprocal
compensation.⁷³ This has become a major issue of contention because it often is not
economically feasible for a wireless carrier to interconnect directly with a rural LEC
without use of an intermediate carrier network.
Although rural LECs’ serving areas sometimes cover large geographic areas,
they tend to serve only a relatively small number of customers and often are not
located near major population centers. Wireless carriers may deploy towers to serve
those same rural areas, but it is not economically feasible to deploy switches in many
of those rural areas. Even many of the traditional wireline long distance companies
do not interconnect directly within each rural LEC’s local calling areas. As a result,
often rather than a direct, physical point of interconnection, traffic between rural
LECs and wireless carriers (and long distance carriers) is carried over the facilities
of an adjacent ILEC or a large long distance carrier that does interconnect directly
with the rural LECs. There will be a point where the traffic is exchanged for billing
purposes, but it is not a physical interconnection point.
Conflict has arisen because under current rules the interconnection and
intercarrier compensation rules differ for local and long distance traffic, and the rural
LECs and wireless carriers have the incentive to define and route traffic differently.
Consider the example of a subscriber to a rural LEC making a telephone call to a
neighbor’s wireless telephone, where the wireless carrier’s switch is in an adjacent
ILEC’s serving area and where both the adjacent ILEC and a major long distance
carrier directly interconnect with the rural ILEC’s network. In that case, the call must
be routed from the rural LEC’s switch to the wireless carrier’s switch outside the
rural LEC’s calling area and then back to the called party in the rural LEC’s calling
area.
The wireless carrier will want that traffic to be treated as local (intraMTA)
traffic and routed from the rural LEC’s switch to the point of interconnection (meet

⁶⁹ Id. at para. 126.
⁷⁰ Id. at para. 129.
⁷¹ See footnote 10 above.
⁷² ICC FNPRM at para. 137.
⁷³ Id. at para. 137.

point) with the adjacent ILEC, where it would then be routed over the adjacent
ILEC’s facilities until it reached the wireless carrier’s switch. The call then would
be routed over whatever facilities the wireless carrier had in place to reach its
wireless tower in the rural LEC service area and then to the called party’s wireless
telephone. In this situation, for the origination segment of the call, the rural LEC and
ILEC would be exchanging the local traffic using either bill-and-keep (which incurs
no charge) or cost-based reciprocal compensation.
In contrast, the rural LEC will want that traffic to be treated as long distance and
routed from the rural LEC’s switch to the point of interconnection with the long
distance carrier’s network, which would then either route the traffic directly to the
wireless carrier’s switch (if there was sufficient traffic with that wireless carrier to
justify a dedicated line to the wireless switch) or route the traffic to the adjacent
ILEC’s network, from where it would be routed to the wireless carrier’s switch. As
in the previous case, the call then would be routed over whatever facilities the
wireless carrier had in place to reach its wireless tower in the rural LEC service area
and then to the called party’s wireless telephone. In this situation, the rural LEC will
claim that use of the long distance carrier’s facilities renders the call a long distance
call, even if it began and ended in the same MTA (and may never have left that
MTA), and therefore it is entitled to receive above-cost originating access charges
from the long distance carrier (who would pass those costs along to the wireless
carrier as part of its negotiated agreement to provide transit service).
If comprehensive intercarrier compensation reform were implemented and
intraMTA/interMTA distinctions were eliminated, this would no longer be an issue.
But if the unique requirements of rural areas justify maintenance of some of the
current intercarrier compensation rules for rural LECs, this issue of the appropriate
intercarrier compensation payments to and by interexchange carriers when they are
acting as transiting carriers will remain.
The FCC has sought comment on how to compensate transiting carriers under
a bill-and-keep system.⁷⁴ Since end users will not have any relationship with the
transiting carrier, the issue becomes how to identify whether the payment
responsibility falls on the carrier to which the calling party subscribes or the carrier
to which the called party subscribes.
How can intercarrier compensation reform take into account
the special needs of rural carriers and universal service
funding?
Why this matters.
It has been longstanding U.S. telecommunication policy to keep rates
“affordable” for subscribers located in high cost rural areas by allowing rural LECs
to charge long distance carriers above-cost access charges and by requiring long
distance companies to offer services at nationally averaged rates. If the first of these
implicit universal service subsidies is eliminated as part of intercarrier compensation

⁷⁴ ICC NPRM at para. 71 and ICC FNPRM at para. 121.

reform, rural carriers may need a stable and sustainable alternative source of
universal service support that is competitively neutral and not likely to be eroded by
future market developments.
Analysis and discussion.
According to the National Telecommunications Cooperative Association, rural
LECs receive on average 10% of their revenue from interstate access charges and
16% from intrastate access charges. In comparison, the Bell operating companies
receive only 4% of their revenue from interstate access charges and 6% from
intrastate access charges.⁷⁵ With rural ILECs far more dependent on above-cost
intercarrier compensation charges than urban LECs, it is not surprising that three sets
of rural carriers have submitted to the FCC proposals for intercarrier compensation
that specifically address the needs of rural carriers.⁷⁶ In addition, Western Wireless,
a wireless carrier that has been designated as an eligible telecommunication carrier
(“ETC”)⁷⁷ in 14 states where it offers service in rural, high cost areas, has submitted
a proposal.⁷⁸ (The proposals made by non-rural parties also specifically address rural
issues.⁷⁹)
The proposals by rural carriers vary widely.
The Expanded Portland Group (“EPG”) proposal, presented as an alternative to
the bill-and-keep proposal in the ICF plan, has three stages. In the first stage, the
current access charge exemption for ISPs terminating traffic to the public switched

⁷⁵ ICC FNPRM at para. 107.
⁷⁶ The Intercarrier Compensation Reform Plan of the Alliance for Rational Intercarrier
Compensation (“a group of small telecommunications companies providing service in the
rural, high-cost areas of the nation”), submitted October 25, 2004; A Comprehensive Plan
for Intercarrier Compensation Reform developed by the Expanded Portland Group (“small
and mid-size Rural Local Exchange Carriers (RLECs), and consulting organizations serving
the RLEC community”), submitted November 2, 2004; and Updated Ex Parte of Home
Telephone Company, Inc. and PBT Telecom (two rural LECs), submitted November 2,

2004.

⁷⁷ An ETC is a carrier eligible to receive universal service support funds.
⁷⁸ Western Wireless Intercarrier Compensation Plan, submitted on December 1, 2004.
⁷⁹ The Intercarrier Compensation Forum would replace the current system with a bill-and-
keep system, but would explicitly take into account the unique needs of rural carriers and
subscribers by setting different interconnection and compensation requirements when one
of the interconnecting carriers is a rural carrier (for example, rural LECs would have no
obligation to deliver originating traffic beyond the boundaries of their serving areas), by
setting a lower limit on the level to which end-user subscriber line charges (“SLCs”) could
be increased, by creating two new universal service funding mechanisms to replace the lost
revenues from above-cost access charges, and by setting a longer transition period for rural
carriers. The CBICC proposal developed by a group of CLECs, which would immediately
reduce interstate access charges to total economic long run incremental cost, would let a
Joint State-Federal Board determine how to transition intrastate access charges to TELRIC,
and would ensure that any reduction in access charge revenues be fully offset by increases
in end-user charges and in universal service support.

telephone network would be eliminated. In the second stage, all per-minute rates
would be set at the level of interstate access charges and a new Access Restructure
Charge (“ARC”) would be implemented. The ARC would be a capacity-based
charge for all carriers based on working telephone numbers, but the revenues
generated would be distributed only to those carriers that lose access charge revenue
(that is, wireline carriers, but not wireless carriers). In the final stage of the EPG
plan, the per-minute access charges would be converted to a capacity based “port and
link” structure that would be set to recover the average equivalent interstate per-
minute rate. The port and link charges would not be cost-based and would not apply
to local traffic, including EAS and ISP-bound traffic. Thus, although the separate
ARC would replace some of the implicit subsidies currently in usage-based rural
LEC access charges, it appears that the port and link charges imposed on
interconnecting carriers would continue to include some subsidy level unless
interstate access charges had already fallen to cost during the second stage.
The Alliance for Rational Intercarrier Compensation proposal for a Fair
Affordable Comprehensive Telecom Solution (“FACTS”) plan proposes a unified
per-minute rate for all types of traffic that would be capped at a level based on a
carrier’s interoffice embedded costs. The unified rate would be charged to the retail
service provider (the originating LEC) on a local call or the interexchange carrier for
both origination and termination of long distance calls. The FACTS plan also
includes a proposal for extending this compensation regime to IP-enabled services.
In addition, it proposes local retail rate rebalancing, which would allow rural LECs
to raise local rates to partially counter the reductions in access revenues.
Under the Home Telephone Company and PBT Telecom (“Home/PBT”)
proposal, all carriers offering service to customers who make telecommunications
calls (including VoIP) would be required to connect to the public switched telephone
network and obtain numbers for assignment to customers. The plan would replace
existing per-minute access charges and reciprocal compensation with connection-
based intercarrier compensation charges. Every carrier would develop a tariffed
charge to be assessed on all interconnected carriers based on a DS-0 (voice-grade)
level of connection. The connection charge is intended to cover the switching and
transport costs for use of the local calling network. If the carrier has an access
tandem, it would develop an alternative access tandem connection fee that would
include the additional costs of the tandem service. Network interconnection between
carriers would be accomplished through one POI per LATA, but where a rural LEC
is involved the POI must be within the rural LEC’s serving area (that is, the rural
LEC would have no responsibility to transport traffic beyond its serving area border).
To help offset revenues lost from elimination of the current intercarrier compensation
charges, the Home/PBT proposal permits carriers to increase the subscriber line
charge (the current end-user charge intended to recover traffic-insensitive costs) up
to the current federal cap. Any remaining revenue shortfall may be recovered from
a new intercarrier cost recovery fund, called the high cost connection fund (“HCCF”).
The HCCF would be funded through a monthly assessment based on activated
telephone numbers and that assessment could be passed through to subscribers. The
consequence of this plan appears to be that access charges currently imposed on
carriers would be placed on the number which allows connectivity to the network.

Western Wireless proposes a unified bill-and-keep system for all types of traffic.
It would reduce per-minute compensation rates to bill-and-keep in equal steps using
targeted reductions over a four-year period, with a longer transition period for small
rural ILECs. Over those four years, ILECs would be permitted to increase subscriber
line charges as proposed in the ICF plan, except that there would be no difference
between the SLC caps for rural and non-rural ILECs. At the end of the four years,
the SLC would be deregulated for an ILEC that could demonstrate that it is subject
to competition. The Western Wireless plan also would replace all existing universal
service mechanisms with a unified high cost mechanism based on forward-looking
costs. This new support would be fully portable to all designated ETCs and
additional portable funds could be disbursed in states with forward-looking costs
higher than the national average. The universal service reform also would be phased
in over four years — and over six years for the smallest rural ILECs and ETCs.
These proposals show that neither rural carriers nor non-rural carriers are of a
single mind about how to implement rural LEC intercarrier compensation reform.
They also demonstrate that, even among the parties that prefer cost-based intercarrier
compensation rates to a zero-price bill-and-keep system, there is no consensus on the
costing methodology that should be employed to set intercarrier compensation rates.
Moreover, they highlight several contentious issues.
^!Although all parties recognize the need to create new explicit
universal service funding mechanisms to help replace the current
implicit subsidies in rural LEC access charges, no consensus exists
on (1) whether the rural carriers should be guaranteed universal
service funds sufficient to replace all lost revenues (sometimes
called “revenue neutral” intercarrier compensation reform), (2) what
specific structure the new universal service funding mechanisms
should take, or (3) whether rural ILECs should have preferential
access to those funds over new entrants, such as rural wireless
carriers.
^!Although all parties agree that the transition period for implementing
comprehensive intercarrier compensation reform will have to be
longer for rural LECs than for other carriers, there is no consensus
on how long that transition should be and the specific steps within
the transition.
^!Although all parties agree that end-user charges will have to
increase, there is no consensus on whether rural subscriber line
charges should be lower than urban subscriber line charges because
rural local calling areas reach fewer households than urban ones.
Can intrastate intercarrier compensation rates and rate
structure be modified by federal action?
The current intercarrier compensation rates that most exceed cost are intrastate
access charges imposed on long distance carriers and wireless carriers for the
termination of certain calls. In addition to providing inaccurate market signals and

discouraging usage, these high intrastate access charges distort competition. For
example, since MTA boundaries are far broader than local calling areas, in many
cases when a telephone call is made between two points in a state, those points are
in different local calling areas but the same MTA. If the calling party and called
party are both using wireline telephone, the calling party’s long distance carrier
would have to pay the called party’s carrier above-cost intrastate access charges. But
if the calling party were to use a wireless telephone, which is subject to federal rather
than state jurisdiction, the calling party’s wireless carrier would only have to pay the
called party’s carrier cost-based reciprocal compensation rates. This gives the
wireless carrier a competitive cost advantage over the wireline long distance carrier.
Some state regulators are likely to prefer to maintain above-cost intrastate access
charges, especially for small rural LECs, in order to help keep local rates down.
Intrastate access charges, which are imposed on intrastate telecommunications
services, historically have been within the sole jurisdiction of state regulatory
commissions. But section 254(b)(5) of the 1996 Act⁸⁰ states as a principle that there
“should be specific, predictable and sufficient Federal and State mechanisms to
preserve and advance universal service” and section 254(e)⁸¹ states that any universal
service “support should be explicit and sufficient.” Implicit universal service
subsidies in access charges do not meet these requirements.
In reviewing each of the intercarrier reform proposals already submitted and the
potential compromises or alternatives that may be proposed by parties or by the FCC,
it will be necessary to determine (1) whether the FCC would have the statutory
authority to implement the specific proposed changes in the rates and rate structure
for intrastate services on its own; (2) if involvement of a Joint Federal-State Board
in the process would provide sufficient state input to meet statutory requirements;
and (3) if there are any aspects of intrastate intercarrier compensation reform that are
beyond the authority of the FCC.
Why is intercarrier compensation regulation not needed for
the networks that comprise the Internet?
Today, there are specific regulatory intercarrier compensation rules for
interconnection arrangements between all types of carriers interconnecting with the
local telephone network, and for all types of traffic passing over the local telephone
network. But there are no analogous rules for the networks that make up the Internet,
which are not regulated and for which intercarrier compensation is left to market
negotiations. Why is it possible to rely on the market to set intercarrier compensation
rates within the Internet, but not to set intercarrier compensation rates for
interconnecting with the local telephone network?
In part, this is the result of historical accident. The Internet, from its inception,
has been a network of interconnecting networks, whereas the public switched
telephone network was for almost a century a monopoly network with little need for

⁸⁰ 47 U.S.C. § 254(b)(5).
⁸¹ 47 U.S.C. § 254(e).

interconnection. There has never been a single Internet backbone network provider
that was so large, relative to other Internet backbone providers that it (1) would
benefit from refusing to interconnect with the other Internet backbone networks or
(2) could offer its customers beneficial interconnection rates, terms, or quality of
service, to the detriment of customers of other Internet backbone networks. When
there was concern among the antitrust authorities in the United States and Europe
that the merger of WorldCom and Sprint might result in a single Internet backbone
network large enough to “tip” the market, the merger was blocked. Similarly, it is
likely that the Department of Justice and FCC reviews of the proposed SBC-AT&T
and Verizon (or Qwest)-MCI mergers will explicitly address whether the resulting
entities would have market power in the Internet backbone market. Thus, the
backbone Internet networks are in effect transiting networks for which there are
competitive alternatives available.
Also, unlike the situation with the local public switched telephone network, in
which a called party will not care if its carrier charges high rates to the calling party’s
carrier to terminate communications, the Internet equivalent to the called party — the
party providing the database or video stream or other Internet application — will not
want Internet backbone providers to charge ISPs high interconnection charges
because these would ultimately have to be passed on to end-user customers and thus
could dampen demand for their own offerings.
Overarching Issue: How Can the Complexities of
Intercarrier Compensation be Most Effectively
Addressed in Statutes and in FCC Regulations?
Intercarrier compensation affects all aspects of the telecommunications market
— investment decisions, competition, innovation, responsiveness to consumer
demands. Given the large number and variety of entities that already interconnect
with one another and the currently unknowable directions that technology and
creativity may take in the future, most observers agree that it is impossible to project,
predict, or devise regulatory rules for all future intercarrier relationships. At the same
time, however, in a network industry, the rules of the game for interconnection will
either foster or stifle efficient competition and innovation. If, in the absence of
regulation, firms with market power are able to dictate the terms and conditions of
interconnection, consumers may not be well served.
Policy makers face choices ranging between the extremes of setting complex,
detailed rules that prove too inflexible to effectively address all the interconnection
permutations that arise in the future and setting overly broad guidelines that fail to
provide sufficient marketplace certainty and thus perpetuate the current litigious
environment. Fortunately, there are some factors that will affect the relative efficacy
of the various approaches to intercarrier compensation.
^!Where underlying costs are difficult to measure and thus it is
difficult to set regulated prices that provide accurate market signals,
intercarrier compensation systems that avoid prices, such as bill-and-
keep, may be advantageous. On the other hand, if a zero price masks

serious usage-driven costs, a bill-and-keep approach may be
harmful.
^!Where effective competition already exists (for example in the
Internet backbone), the risk from erring on the side of little or no
regulation may be low. On the other hand, where competition is
ephemeral, that risk becomes much greater. Market-negotiated
intercarrier compensation terms, conditions, and rates avoid the
inevitable distortions associated with regulatory fiat, but market-
driven results could be even more distorted if one party can negotiate
interconnection terms, conditions, and rates from a position of
market power.
^!Broad principles and detailed rules need not be mutually exclusive.
The Intercarrier Compensation Forum has constructed an extremely
detailed proposal that begins with default rules based on a small set
of basic principles and then expands on these rules for specified
exceptions, such as rural local exchange carriers. This type of
approach, while far too detailed for statutory language, might prove
viable for FCC regulation.
^!A crucial evaluative criterion for any proposed intercarrier
compensation regime would be its susceptibility to, or inhibition of,
extensive litigation. One of the few areas in which there is industry
consensus is that a well-defined intercarrier compensation regime is
needed that will reduce the current costs of litigation.