DESPITE HIGH SUBSIDIES, V.I. PHONE USERS PAY MORE

Second of two parts
June 19, 2002 – Innovative Telephone collects $25 million a year from a Washington-based not-for-profit entity that administers what is called the Universal Service Fund. The V.I company's subsidies work out to be much more per line than is received by any other phone company of its size, or by any other phone company serving the U.S. insular territories.
The subsidies are based on a formula that applies nationwide in the distribution of money from the federally sponsored fund, which was established years ago as a vehicle for making basic telephone service affordable to low-income users in rural areas and other remote locations. The fund's revenues come from charges, typically of about $2 a month, that are levied on phone bills throughout the nation. Some of this appears on monthly statements, such as the 34-cent charge shown in recent months on Virgin Islands phone bills, but more is hidden within the basic phone rate.
Innovative Telephone, formerly the V.I. Telephone Corp. (or Vitelco), receives subsidies totaling $31.20 per line per month through the subsidy system, which is described below. Through the same system, the local telephone service provider for American Samoa gets a subsidy of $4.01 per line per month and that of Guam gets $2.12 per line per month.
Meanwhile, on the mainland, no other phone company with as many lines as Innovative — about 69,000 currently — gets anywhere near the Virgin Islands company's level of subsidies. Not even Glacier State Telephone Co., whose lines extend over huge distances in Alaska; it draws $24.13 per line.
The monthly payments are part of a national scheme in which urban residents served by efficient phone companies operating with economies of scale subsidize the costs of some rural and island phone users. The dollar figures quoted are for the current year and are taken from the web site of the National Exchange Carrier Association, one of two not-for-profit companies that administer the subsidy programs for the federal government.
Innovative receives funding from two subsidy programs: the High Cost Loop program, which is intended to reduce the costs of local telephone service, and the Long Term Support program, which is to do the same for long-distance service. Innovative gets a subsidy of $22.07 per line per month from the High Cost Loop program and another of $9.13 per line per month from the Long Term Support program.
There also are small-scale subsidy programs for low-income phone users, helping no more than 800 customers in the Virgin Islands, and a program segment for schools and public health facilities. Innovative passes these program funds through to program beneficiaries in the form of reduced phone bills.
All of the High Cost Loop and Long Term Support subsidies, on the other hand, go directly to the telephone company.
More is known about the workings of HCL than the LTS program. Essentially, Innovative gets a lot of High Cost Loop support because it runs a high-cost operation. The HCL formula does not take into account topography, the income of the population served or anything other than the costs reported by the telephone company to Washington. Neither subsidy program pays any attention to the rates charged by a local phone company, the amount of interest it is paying to its lenders, or the level of its profits.
High costs add up to high subsidies
Cost alone is the criterion, and since Innovative Telephone reports its costs at two-and-a-half times the national average, it secures very large subsidies.
The exact formula for calculating the costs leading to the HCL subsidies is known only to a handful of people within the two not-for-profit entities that handle the money — the National Exchange Carrier Association (NECA) and the Universal Service Administrative Company (USAC) — and presumably some people within the telephone companies.
The Source has seen the elements of the formula, which runs to three pages of complex equations, and the reporting system covering 60 or so items that feeds into it. Further, a USAC official has told the Source that in cases where a company reports above-average costs, it is compensated at the rate of 65 percent for costs that are15 percent to 50 percent above the norm, and at the rate of 75 percent for costs that are more than 50 percent above the norm.
While the output of the subsidy system — in this case, some $25 million a year to Innovative Telephone — is published, just how these cost levels are calculated remains to some extent a mystery.
Telephone industry insiders note, however, that historically the higher a company's costs, the greater its subsidy. This has been a pattern in the business since the days of Ma Bell's monopoly. Back then, rates were set by public regulators so that AT&T could get, say, a guaranteed 9 percent return on its investment. Since the phone company could borrow money for a little less, say 8 percent, it had a good reason to build expensive systems — and, in effect, collect 1 percent a year (in this particular example) on someone else's money.
As executives at various telephone companies contacted by the Source made clear, some companies see the situation as an opportunity for "gold plating" a system and being financially rewarded for it.
One thing known about the HCL formula is that it takes into account the depreciation of property. And the more property a phone company has to depreciate — that is, the greater its capital investment — the larger the subsidy, according to a NECA official.
In corporate finance, depreciation is regarded as a business cost; it is the decline in the value of an asset. Say you buy a car for $20,000. If it has an expected life of 10 years, then it depreciates at the rate of $2,000 a year. At the end of 10 years, the full value of the car has been depreciated, and it is probably time to buy a new one, if you have not done so earlier.
Depreciation is an attractive sort of cost to many businesses: Yes, the car is worth $2,000 less at the end of the year, but there was no negative cash flow during the year, and the $2,000 can be matched against an equal amount of revenue that otherwise might be regarded as profit for tax purposes.
In the example of the car, its depreciation was $2,000 a year based on a 10-year life. But if its life had been regarded as five years instead, the depreciation would have been $4,000 a year.
The Source asked the NECA official, regarding the telephone companies it subsidizes, "Who decides on depreciation rates?" In other words, who decides if the car creates $2,000 or $4,000 worth of depreciation in the course of a year?
The NECA official replied: "The local public utilities commission."
Efforts by the Source to obtain comment from the Public Services Commission in this regard and others involving Innovative Telephone were unsuccessful. A phone message was left for the executive director inquiring about how the commission figures depreciation for the telephone company; the call was not returned.
The Source also asked by telephone to see any financial reports filed by Innovative; the response was that the PSC would answer only a written request. Three weeks ago, the request was submitted in writing; there has been no response. However, the agenda for this Friday's PSC meeting, distributed to the news media last Friday, lists as one of six "Innovative matters" to be taken up an item reading "action on request by The Source for release of financials."
Unusually high depreciation reported
A review of the Federal Communications Commission web site shows that Innovative Telephone reports, by any standard, an unusual amount of accumulated depreciation. This reflects, if imprecisely, the accumulated level of subsidies paid in the past. The accumulated depreciation is not part of the current year's subsidy calculation.
Here are the numbers for accumulated depreciation per customer to date for the Virgin Islands com
pany and the averages for some others:
Innovative — $2,085 per line
Other island companies, unweighted average — $1,158 per line
Sampled mainland companies, unweighted average — $1,363 per line
The "other island companies" referenced are two firms in Puerto Rico, one on Guam (similar in size to Innovative) and another, the smallest, in the Northern Mariana Islands. The actual accumulated depreciation reported per line for these companies ranged from $1,025 to $1,274.
The "sample of mainland companies" consisted of 22 firms, using the first two firms listed on each of the first 11 pages of the full FCC listing of phone companies receiving subsidies. Of the 22 companies, 20 reported lower amounts of depreciation per line than Innovative. The other two, which had slightly larger amounts, were two tiny firms with 1,115 and 3,038 lines, respectively, that have none of the economies of scale enjoyed by the Virgin Islands company with its 69,000 lines.
Innovative's unusually high amount of depreciation would seem to signify one of three things:
– The company must have one of the newest, fanciest, strongest and most sophisticated telephone systems in the nation.
– The company has been paying about 60 percent more for normal equipment than other U.S. telephone companies, including other island systems.
– There have been some major accounting mistakes.
No other possible explanations are apparent. But whatever the explanation, the amount of current depreciation plays into the phone subsidy formula, and has done so for years, in a way that would seem to have benefitted Vitelco, and now Innovative.
The depreciation factor works over a long period of time. For the latest Federal Communications Commission report, covering 1999, Innovative told the FCC that it had "zero" current expenses for "operator systems," since the traditional operators had long been gone. But it also reported depreciation of $11,000 for the year on the presumably unused "operator system equipment." One might visualize a dusty old switchboard, sitting in the back room, doing nothing — except, by its very presence, racking up $916.67 worth of depreciation costs per month for Innovative.
Innovative's expenses are far higher than those of the other island companies on many variables. For example, these are the FCC's reported costs per line in 1999 for the Virgin Islands and Guam telephone systems in four major categories:

Guam's phone system is government owned, and the government of Guam, like many other island governments, is not often cited as a model of efficiency. Still, its telephone costs are considerably lower than those of Innovative, which is privately held. Guam has a slightly larger system, with about 80,000 lines to Innovative's 69,000.
Guam's reports to the FCC, incidentally, are worked out to the last dollar, while many of Innovative's are rounded to the nearest thousand.
If you want to check out these numbers and a lot more, you can do so on the Internet, but you must be prepared to unzip some of the files. Go to the National Exchange Carrier Association web site and then click on "Universal Service Fund Data: NECA Study Results/1999 Report, USFOOR99.ZIP." You will find Innovative, along with the other island telephone systems, at the very end of the listings. You will also need to download "Universal Service Fund Data Definitions" to make sense of the numbers.
While there are many types of data in this 1999 report, all relate to costs. There is nothing on such matters as rates charged, income derived, or profits secured by the companies. This is the latest report available on the web site. The Public Services Commission, if it has not already done so, might well be able to secure more recent data if it asked or directed Innovative to provide it.
Despite high subsidies, a high consumer rate
If the local telephone company gets a remarkably high subsidy in a program designed to lower costs to consumers — as Innovative Telephone does – it might seem logical to assume that the rates paid by Virgin Islands phone users would be at or below the national average.
The findings of a study reported in February by the General Accounting Office, the congressional watchdog agency, suggest this is not the case. While the GAO report, "Federal and State Universal Service Programs and Challenges to Funding," did not deal with telephone subsidies to any of the insular companies, it did sample basic monthly telephone rates in 508 jurisdictions scattered throughout the 50 states and the District of Columbia.
The GAO study, which covered the period May through September of 2001, did not address the profit margins of the 508 systems studied, nor did it discuss their cost structures. The principal thrust of the study was not on the equities within the Universal Service system, but on the prospects for the subsidy programs as more and more telephone users bypass the traditional phone system by using the Internet and other communications systems, none of which are taxed to subsidize rural and insular telephone users.
Nonetheless, the data provide meaningful insight into what Innovative's exceptional subsidies have meant in terms of affordable service for its customers.
If Innovative Telephone's basic customer service rate of $18.55 a month were to be plugged into the range of rates reported by the GAO, it would fall at the 92nd percentile. In other words, about 91 percent of the monthly phone rates reported by GAO were lower than those in the Virgin Islands, and about 8 percent were higher than those charged by Innovative.
The reported rates range from $7.45 a month in Atlantic City, New Jersey, to $43.95 in several Michigan locations. These rates at both extremes, like those in the Virgin Islands, were charged by for-profit corporations.
Most of the basic rates reported by the GAO lay between $10 and $16 per month. It is noteworthy that the overwhelming majority of mainland telephone companies do not benefit from any kind of Universal Service subsidy, and thus their customers do not benefit from any lowering of basic service costs that such subsidies might make possible.
The bottom line for Virgin Islands telephone users, then, is this: While their service provider has for years received massive and exceptional Universal Service Fund subsidies, which are intended to make basic phone service affordable, the system has failed to bring the cost of that service to the customer down to anywhere near the national average.

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