I. Introduction

We address the question of whether "reciprocal compensation" should be paid for telephone calls that are bound to the Internet through Internet Service Providers (ISPs). "Reciprocal compensation" as defined by the Telecommunications Act of 1996 (Act) provides recovery of the costs incurred by carriers to terminate local telephone calls.¹ In opening this rulemaking, we stated we would examine, among other things:

1. the nature of ISP traffic,

2. the basis and justification for reciprocal compensation and consideration of revenues competitive local exchange carriers generate in providing access service to ISPs,

3. the impact of the Federal Communications Commission's (FCC) February 25, 1999 Declaratory Ruling on Decision (D.) 98-10-057, as modified by D.99-07-047,

4. alternative compensation arrangements, and

5. if warranted and proper, the level and make up of a proper reciprocal compensation rate(s) for ISP-bound traffic.

Based on the record before us, we conclude that ISP calls do not meet the criteria for local calls and thus are not subject to mandatory reciprocal compensation. We eliminate the current requirement for reciprocal compensation payment and in its place we establish as a preferred outcome bill-and-keep or other mutually agreeable inter-carrier arrangement that carriers propose in their interconnection agreements.

We eliminate reciprocal compensation because we find that a call to the Internet via dial-up access is not a local call. Although this conclusion is sufficient to rescind reciprocal compensation, our examination of the economic, competitive, financial and consumer consequences of reciprocal compensation lead us to the same conclusion.

We find that traffic to ISPs has certain unique characteristics that significantly distinguish it from standard two-way voice traffic. An ISP-bound call is typically longer in duration, as much as ten times longer than a two-way voice call. The call completion rate (the rate by which the call is answered) is higher for an ISP call than for two-way voice call (95% versus 75%, respectively). CLECs who focus on ISP customers to generate calls for reciprocal compensation purposes primarily use technology and network architecture that are specifically designed for high-speed data rather than two-way voice traffic transport and termination with the apparent objectives of reducing switching and transport costs. These differences in network architecture and traffic characteristics, combined with provisions of the Telecommunications Act of 1996 for reciprocal compensation for standard voice traffic have created exploitable conditions for certain CLECs. These CLECs have targeted ISPs not due to competitive advantages but primarily due to arbitrage opportunities to the detriment of genuine competition in the communications market and our universal telephone service goals.

We find that, if left unchanged, the current reciprocal compensation policy for ISP traffic will continue to produce many consequences that will adversely affect residential telephone service, the deployment of advanced telecommunications services, new investment in telecommunications, and competition.

We find that the policy of reciprocal compensation for ISP calls poses serious inflationary threat to residential telephone service. Residential telephone service rates are currently priced below their fully allocated cost for universal service purposes. Therefore, to continue reciprocal compensation payments, as an unfunded subsidy of ISP traffic, the Commission may find it necessary to increase local telephone service rates across all local telephone service subscribers.

The record before us also shows that reciprocal compensation under the current policy is inequitable and unsustainable. It creates market distortion in the Internet access market. It establishes a preference for dial-up access to the Internet and will retard and may foreclose certain segments of consumer markets from receiving advanced Internet access services. For all these reasons we eliminate reciprocal compensation for delivery of ISP-bound calls and in its place adopt bill-and-keep as a preferred outcome in interconnection agreements.