Introduction

Mr. Rubin's remarks contain a number of factual errors and a series of unsubstantiated statements and conclusions relating to the LIPA Plan. In addition, Mr. Rubin, a lawyer, offers no alternative to the LIPA plan. Listed below are pertinent sections of Mr. Rubin's remarks in bold faced type followed by LIPA's responses.

Mr. Rubin's assertions are wrong. He states, "In 1996, LILCO paid about $715 million to its investors. LIPA estimates that it would pay $707 million in interest in the first year - basically no savings at all." Mr. Rubin's reference to LIPA's costs relate to the chart below in which LIPA estimated the benefit of the LIPA Plan using LILCO's rates for the 1997 rate year as a benchmark.

The $715 million cost of capital for LILCO that Mr. Rubin uses is the amount of interest, preferred dividends and common dividends for the entire company - electric T&D (which LIPA has agreed to buy), and generation and gas (which LILCO will retain), but excludes approximately $207 million of depreciation and amortization which LILCO rate payers pay today. In contrast, LIPA's estimate of capital cost of $707 million included principal, interest and debt service coverage (revenues charges to provide additional bondholder security). LILCO's rates are not based on the cash paid to investors but rather on the "return on rate base and cost of service" ratemaking methodology applicable to regulated investor owned utilities ("IOU"). As Mr. Rubin should know, an IOU's capital charges consist of return on capital, including interest on debt, allowed returns to equity holders, a return of capital on asset depreciation, and amortization (a proxy for principal payments). The $854 million in capital cost shown for LILCO in the chart on the prior page includes these components.

As shown in the chart on the prior page, LIPA's cost of capital advantage is $147 million, approximately one-half of the underlying savings, not the $8 million referred to by Mr. Rubin. Finally, Mr. Rubin does not dispute that LIPA will realize Federal income tax savings of $180 million annually.

Mr. Rubin reaches this conclusion by ignoring LILCO's Shoreham related regulatory assets of $4.7 billion, an absurd position since rate payers on Long Island have been and will continue to pay LILCO for these assets pursuant to the 1989 Settlement Agreement.

LIPA has provided compelling analysis which shows that electric rates will decrease by an average of 17% upon LIPA's acquisition of LILCO. Furthermore, Mr. Rubin ignores the very real economic benefits to be realized on Long Island as a result of the cumulative $5 billion of lower electric rates over ten years which the LIPA transaction will produce.

"[LIPA assumes that] The electric industry is an old, stodgy, highly regulated industry."

LIPA has made no such assumption. As competition has been evolving in the U.S., the natural monopoly, the transmission and distribution ("T&D") business, is remaining rate regulated and the generation business is becoming a competitive business over time. That is why LIPA has designed its business plan to phase in wholesale power and energy supply competition as well as retail power supply choice while keeping its T&D rates tied to cost with incentives to drive down those costs.

"[LIPA assumes that] Electric rates will continue to go up."

LIPA believes LILCO's nominal rates will increase in the 1999-2001 time frame for three reasons. First, as part of the 1989 Settlement Agreement, LILCO was ordered to refund to customers, over a ten year period beginning July 1, 1989, amounts referred to as the 1989 Settlement Credit and the Regulatory Liability Component. The annual amortization of these amounts equals $88.6 million. Once these amounts are fully refunded to rate payers in mid 1999, this annual refund credit ends, and LILCO's cost of service will increase leading to higher rates.

Second, as part of the 1989 Settlement Agreement, in order to mitigate the potential rate shock of the Settlement, the Rate Moderation Component ("RMC") was created. The RMC (a balance of $402 million at December 31, 1996) represents deferred revenues that would otherwise have been collected from rate payers under the Settlement Agreement in prior years that under the Agreement were to be recovered from rate payers by December 1, 1999. Any amounts not otherwise recovered by December 1, 1999 are proposed to be recovered in rates on a straight line basis together with a return on the unrecovered amount during the period from December 1, 1999 through December 31, 2001. The projected increases in LILCO's rates through 2001 are designed to recover the projected unrecovered RMC balance.

Third, the operation of any utility involves labor, fuel, material and other costs, all of which are subject to inflation. For instance, LILCO signed a five year agreement with its unions in 1996 which provided for an average increase of approximately 3% in salaries for covered union employees. Normal increases in such costs due to inflation will ultimately be reflected in rates. To the extent such cost increases do not occur, both LIPA and LILCO rates shown in the comparison would be lower and the savings would remain the same.

"[LIPA assumes that] There will not be any competition for the supply of electricity."

LIPA will provide for competition for power supply at the wholesale and retail level immediately upon its acquisition of LILCO. LIPA will develop a competitive power supply solicitation process for the incremental needs of capacity on Long Island, which, at present, is projected to increase by approximately 60 megawatts (MW) to 80MW annually, inclusive of capacity reserves needed to meet the New York Power Pool operating requirements. Between now and the summer season of 1999 (the first peak season that LIPA would be responsible for serving under the anticipated transaction schedule), load growth on a weather normalized basis is expected to require, cumulatively, approximately 100 to 150MW of new capacity to meet load and capacity reserve requirements. Under the terms of the agreements between LILCO and LIPA, LILCO will not enter into long-term new power supply contracts between now and the closing date. Therefore, in 1999 LIPA will have the opportunity to back down on short-term capacity purchases that will have been entered into by LILCO between now and the closing. LIPA will initiate a solicitation process to replace LILCO's short-term capacity purchases as well as to provide for incremental projected needs for perhaps 3 to 4 years after the closing.

"[LIPA assumes that] Electric utilities will continue to operate in the world of if we build it, they will come" and "We'll continue to have cost-plus pricing for electricity"

LIPA does not believe the electric utility industry will remain a static, regulated, cost-plus industry with continuing rate increases. That is why LIPA designed its business plan to (i) maximize the benefits of tax-exempt financing to lower its capital costs, (ii) provide incentives for the private sector to operate the T&D system at the lowest possible cost, and (iii) secure power supply at the lowest possible cost by maintaining the option over time either to continue to buy capacity from LILCO's low cost, on-island generators or switch to other power suppliers if they can provide even lower cost power.

The rates for LIPA used in the rate comparison include all the costs related to the management fee and incentives. There are no additional "profits." LIPA has clearly stated that it has conservatively estimated its savings by assuming operational savings equal only to the guaranteed 2% synergy savings imbedded in the basic agreements. However, LIPA believes it will realize greater operational savings.

The Management Services Agreement contains provisions that are designed to protect LIPA's customers from excessive costs. The contract requires that the Manager absorbs the first $15 million of annual cost overruns thereby creating a significant incentive for the Manager to operate within the budget. In addition, the contract provides a further incentive for the Manager to operate more efficiently. The Manager will retain the first $5 million of cost savings and share with the customers 50% of savings in excess of that up to a cap. If cost savings exceed the cap, customers will receive 100% of the benefit of such savings. Because LIPA will be approving the budgets annually, it will be able to ensure that the combined budgets are realistic and that the customer is benefiting from the most efficient operation of the system possible. In fact, LIPA's plan is very much like the incentive regulation schemes adopted by recently privatized utilities around the world.

The Power Supply Agreement contains provisions to assure that the LILCO generation will continue to be available for Long Island, and to cap the costs so they cannot go up beyond that which is justified based on reasonably incurred, necessary costs to maintain plant operation and availability. LIPA will purchase energy from any source which can deliver energy at lower costs to serve customer energy needs. Any savings from this competition will be in addition to the average 17% immediate rate reduction in the LIPA plan. The LIPA plan is not precluding any competition which would otherwise be available to reduce customer rates.

Mr. Rubin's statements are wrong. The $2.1 billion liability that he refers to is a potential liability to the federal government, not rate payers. Under the status quo, rate payers do not have any claims against the company for these amounts. More specifically, Mr. Rubin, in his presentation states, "LILCO has collected $2.1 billion from you to pay Federal income taxes." This is incorrect. In fact, rate payers will have to pay approximately $1.6 billion that will be collected in rates as the taxes become due. Under the LIPA transaction, however, rate payers will get the benefit through lower rates because LIPA will not need to collect these amount because of its tax-exempt status.

As stated in writing to CAP on June 9, 1997, "Based on information provided by LILCO, rate payers are entitled to $60 million per year for 1997, 1998 and 1999, due to the RICO settlement. The payment schedule is based on a year that starts on June 1^st , and the payments are credited to electric bills during the year based on projected sales (not equal monthly payments). LILCO projects for calendar year 1998 through 2000 the following credits to rate payers:

Depending on the date of the closing, LIPA would refund the portion of the $60 million for calendar year 1998 that has not previously been refunded by LILCO as well as the amounts due in 1999 and 2000. LIPA and LILCO have agreed to petition Judge Weinstein after signing the Agreement and Plan of Merger to accelerate the payments to rate payers as one-time checks rather than reductions in electric bills. Because the credits to rate payers would be accelerated under the LIPA Plan, it is likely that the gross payment will be discounted to reflect the time value of money. LIPA believes it is best to get this money into the hands of rate payers quickly to allow them to use it as they see fit rather than to continue to have it credited to their bills over time. Judge Weinstein must agree to any discount rate for the payments. The amount of the checks given to rate payers depends upon the amount of credits remaining, the discount rate on such payments and the date on which the checks would be distributed."

In connection with the negotiations between LIPA and LILCO, LILCO applied the Phase I Shoreham Tax Certiorari judgment to reduce its rate moderation component ("RMC"), one of the regulatory assets LIPA is buying from LILCO as part of the transaction. This reduced RMC balance was reflected in the price LIPA agreed to pay for this regulatory asset. Consequently, LIPA rate payers will receive this benefit through reduced future rates.

It is not clear exactly what Mr. Rubin is referring to as "new marketplace innovations." However, LIPA has incorporated into its business plan innovative arrangements to lower electric rates, foster wholesale power supply and energy competition, maximize private sector involvement, incentivize private sector service providers to lower operating costs, encourage conservation and demand side management, minimize the cost of capital, minimize Federal income tax expense, and introduce retail power supply choice.