This approach results in cash and marketable securities held by the DRVC which are free from all restrictions and in excess of the amount potentially needed to fund any net liabilities. To use an analogy, if you added up all your personal savings and then deducted all illiquid (unavailable) savings and any net liabilities (exclusive of cash), including mortgage debt, credit card debt, tuition requirements, retirement needs and other debt, you'd be left with "free cash reserves".

As can be seen above and in the attached analysis, the total amount of free cash reserves calculated as of August 31, 2003 equals $180.1 million (also see the discussion of the major components of these free cash reserves). This compares to the $119.4 million of free cash reserves calculated as of August 31, 2002. The increase in 2003 is attributable to the inclusion of additional Diocesan entities and "designated funds" (excluded previously due to uncertainty and/or immateriality) and the use of a slightly refined methodology. The details of these changes are summarized in a separate memorandum, which is available upon request. On a comparative basis (without these changes), I estimate that the amount of DRVC free cash reserves increased approximately $13 million in 2003 from 2002.

In my prior year analysis, I estimated the $119.4 of free cash reserves to be equivalent to approximately 4 years of defined DRVC operating expenses, far in excess of the non-profit industry standard of 6-12 months. The DRVC Finance Council took exception to this specific estimate (as well as my entire analysis), so I have summarized its views in the attached summary together with my responses thereto.

This year I refined my analysis of defined Diocesan operating expenses. This refinement (which is discussed in a separate memorandum available upon request) indicates that the Diocese must raise approximately $47.3 million per year to support its operations (out of total combined operating expenses of $167.0 million). This $47.3 million amount includes subsidies provided by the DRVC to its various operating entities but excludes operating expenses subsidized by (1) third party reimbursements from the government and others (Medicare, Medicaid, grants, etc.), (2) subscriptions and fees (Long Island Catholic, the Immaculate Conception Seminary and Catholic Cemeteries), (3) assessments (the Protected Self Insurance and Medical Funds) and (4) tuition (the schools). The activities to which these expenses relate are self-supporting and do not require Diocesan fundraising support. Thus, cash reserves are not required to support these activities. Using this refined $47.3 million estimate of defined DRVC operating expenses, the $180.1 million of free cash reserves noted above is equivalent to 3.8 years of defined operating expenses (compared to my prior year estimate of 4.0 years). This amount of free cash reserves is still extremely conservative by any measure, particularly the 6-12 month non-profit industry standard noted above.

In fairness, it should be noted that $163.6 million of the $180.1 million of free cash reserves have been "designated" for future use by the DRVC. However, as explained in my 2002 analysis, "designated" net assets are not required to be set aside under generally accepted accounting principles ("GAAP"). They are not liabilities. They are like retained earnings in a for-profit entity, which have been divided between a portion that will be retained in the business for future general and/or specific uses, i.e. "designated", and a portion that might be available for distribution as a dividend to stockholders, i.e., "undesignated". Non-profit entities are allowed under GAAP to judgmentally divide their unrestricted net assets between such "designated" and "undesignated" portions. There are no specific rules or guidelines for doing this. The process is completely discretionary and normally only requires board of trustee approval. Using such discretion, the Diocese has "designated" most of its unrestricted net assets for vague future uses, emergencies and inclusion in a "quasi-endowment fund" (with the investment income derived therefrom used currently to support operations).

Obviously, considerable judgment is required in making such designations, and reasonable people can disagree on the need for and amount of such designations. However, I personally believe that the DRVC has been ultra-conservative in designating cash reserves for future uses and emergencies because the DRVC's descriptions of such uses and emergencies are extremely vague, non-specific, unquantified and general. In addition, the donors of these funds certainly never intended them to be set aside into a quasi-endowment fund vs. being used currently for the needs of the Diocese. Therefore, contrary to the DRVC view, I view most of these reserves as "free" and available for current use wherever needed in the community. The "designations" have, for the most part, hidden the true nature of such reserves.

SUMMARY AND CONCLUSION

As I indicated in my prior year analysis and above, I personally believe the Diocese has been far more conservative in accumulating free cash reserves and "designating" them for future use than current human needs within the Diocese dictate. In other words, I believe the Diocese is "over-designating" its unrestricted net assets for vague future uses and emergencies, thereby preventing their use for specifically identifiable current needs in the community. In addition, I don't believe that the donors/parishioners who donated these funds intended for any portion of them to be set aside as a "quasi-endowment fund" or reserved for future general use, particularly during a period of great need in our community (and while balanced budget protocols are simultaneously being imposed on the various Diocesan ministries). Finally, $180.1 million, or 3.8 years worth of free cash reserves, is far more than needed in reserve using any non-profit industry standard. And, this is before even considering the significant value of certain under-utilized properties owned by the DRVC, e.g., the Seminary of the Immaculate Conception.

Because the DRVC Finance Council disagrees with my analysis and related beliefs, I have attached a summary of its criticisms (published in the Long Island Catholic in March 2004) together with my responses thereto (which the Long Island Catholic chose not to publish).

The purpose of my analysis is not to impugn the integrity of the Bishop, his Finance Council or any of his other financial advisors. Rather, the purpose is to generate more thought and discussion on what amount of free cash reserves is advisable and what is the appropriate balance between current and future needs. If I'm wrong, then let the DRVC provide some detailed evidence vs. general, offhanded criticisms. Whether I'm right or wrong, wouldn't it make sense for the DRVC to respond to the following questions?

• Does the DRVC even have a mechanism to balance current human needs with future capital needs?
• If, as the Chairman of the Finance Council now admits, cash reserves are "adequate", then shouldn't any future increases in reserves be used for current needs vs. accumulating even more reserves, particularly given the spiritual and humanitarian mission of the Church?
• In times of critical need such as we face today, wouldn't it make sense to dip into these reserves a little, replenishing them later during better times, vs. cutting back and/or continuing to impose balanced budget protocols on human service programs?
• Does the DRVC have any reasonable guidelines to determine when its reserves become excessive? What are they?
• Why doesn't the DRVC publish combined (consolidated) financial statements to make its financial condition a lot clearer? Is it hiding something?
• If $180.1 million of free cash reserves is not enough, then how much is enough?

PREPARED BY: H. RICHARD GRAFER (richardgrafer@aol.com)
DECEMBER 13, 2004

DIOCESE OF ROCKVILLE CENTRE "FREE CASH RESERVES"
MAJOR COMPONENTS OF "FREE CASH RESERVES"
AS OF AUGUST 31, 2003

Administrative Offices = $53.5 million

$24.0 million of this amount equals what the DRVC refers to as "the mission component" of such reserves, which are "designated" for future parish assistance. However, at the rate of past parish assistance, most of this reserve appears excessive unless such rate of assistance accelerates dramatically in the years ahead. In addition, outstanding loans to all parishes only equals $8.5 million (net of allowances), so even were the DRVC to forgive 100% of these loans (as in Jubilee 2000), $15.5 million would remain available for other uses.

$29.5 million of this amount constitutes a "quasi-endowment fund" created from parishioner contributions and assessments over the years (including a 1% assessment on certain parish/ministry funds deposited with the diocese) and is now "used to produce investment income in support of the diocesan budget." Thus, it is a free cash reserve (although use of any portion of such amount would result in less investment income to support current operations).

Protected Self-Insurance Fund = $52.5 million

This amount is over and above what the independent actuary and independent auditor say is necessary for reported and incurred-but-not-reported claims throughout the diocese (based upon past experience and other factors). Although the Diocesan Finance Council believes it is wise to keep something extra in reserve to protect against unexpected events, the $52.5 million excess reserve is more than 100% (115%) of the actuarially-determined reserve required for all past unpaid claims. In addition, I have excluded the separate $10.9 million Uninsured Perils Fund (maintained for sexual abuse expenses and claims) from the $52.5 million excess reserve amount.

Medical Insurance Fund = $4.6 million

This amount is over and above what the administrator of the plan has determined is necessary for reported and incurred-but-not-reported claims throughout the diocese (based upon past experience and other factors).

Catholic Cemeteries = $44.6 million

This amount consists of $10.1 million of unrestricted and "undesignated" free cash reserves and $16.2 million and $14.7 million, respectively, "designated" for the "future care of mausoleums" and "future maintenance and operation of Holy Rood Cemetery after its primary revenue producing operation has ceased." These amounts appear excessive based upon the historical level of maintenance revenues and operating expenses. In addition, a separate, permanently restricted "Permanent Maintenance Fund" of $46.4 million exists, which appears available for the same uses designated above for the unrestricted $44.6 million amount. This lends additional support to my argument that many of these reserves are excessive. However, not enough information is available to determine the excess amount precisely.

Catholic Charities = $19.0 million

Although $14.8 million of this amount is "designated" for future use, no information is provided to evaluate such designation except for a reference to "Catholic Charities Support Corporation." I have been unable to obtain any information about Catholic Charities Support Corporation. Despite the existence of this $19 million of free cash reserves, Catholic Charities continues to have a balanced budget protocol imposed upon it.

All Other Diocesan Entities Combined = $5.9 million

$3 million of this amount is "undesignated", and $2.9 million is "designated" for future use.

TOTAL DRVC "FREE CASH RESERVES" = $180.1 MILLION

MY RESPONSE TO THE DRVC FINANCE COUNCIL'S CRITICISM OF MY ANALYSIS OF 8/31/02 "FREE CASH RESERVES"

The following is a summary of my response to the Finance Council's criticism of my analysis of the August 31, 2002 Diocese of Rockville Centre ("DRVC") "free cash reserves". (Note: My original analysis was published in the New York Times on March 25, 2004. The Finance Council's criticism of my analysis was published in the Long Island Catholic on March 31, 2004. My detailed response to the criticism was sent to the Bishop and the Long Island Catholic shortly thereafter but was never published) .It should be noted that any summarization of a subject as complex as that dealt with in my analysis and response risks losing the true substance and accuracy of the issue. Thus, reference to the full analysis and response is encouraged when reading this summary (which is available upon request).

Finance Council Criticism: Reserves are necessary for future needs and obligations, and the Diocese follows GAAP:

My Response: I agree, but current needs should not suffer in order to maintain reserves for the future, particularly when many of these reserves are for unknown and/or non-specific uses. In addition, GAAP does not require such reserves as the council implies.

Finance Council Criticism: Mr. Grafer selectively picks three funds and compares their reserve balances to only Administrative Office expenses, thereby erroneously concluding that the Diocese has four years' worth of operating expenses in excess reserves:

My Response: I selected only three funds because those were the only ones that appeared to have "liquid" free reserves in the form cash. I used the Administrative Office expenses as a measure of the amount of excess reserves because there is no other reasonable way to measure the degree of conservatism employed by the diocese. The Administrative Office expenses include the cost of the Diocese's support of its operating entities to the extent that third party sources of revenue are insufficient. Thus, the approach is not unreasonable, and any other approach could be misleading. (Note: In my analysis of the subsequent year's financial statements---8/31/03---I included all Diocesan entities for which financial statements were published and refined my calculation of Diocesan operating costs. I believe that these refinements proved my response above correct.)

Finance Council Criticism: The cemetery fund balance is inadequate to cover the cost of perpetual care contracts and a new cemetery:

My Response: Based upon the level of current annual care expenses, the reserves look sufficient to me to cover the cost of future care on a discounted basis. However, it's impossible to know for sure without more details. In any event, the amounts involved are small in relation to the total amount of excess reserves ($119 million in 2002/$180 million in 2003). Also, a future cemetery site has already been purchased, so that should minimize future development costs. (Note: My detailed response does not mention the fact that the diocese has approximately 200 acres of excess land contiguous to its seminary, which could probably be sold for $50-200 million to fund any reserve shortfall).

Finance Council Criticism: The $10.9 million uninsured perils fund (for sex abuse claims) and the $45.9 million unrestricted self-insurance reserve are absolutely necessary given the fact that the Diocese has substantial deductibles under its insurance program and $2.6 billion of premises to protect:

My Response: I agree that the uninsured perils fund is needed for sex abuse claims, and so I have not included it in my excess reserve analysis. The $45.9 million is an extra reserve over and above what GAAP, the outside actuary and the independent auditors require to cover all past claims, known and unknown. Thus, the $45.9 million is available for current use. I acknowledge that it's not a bad idea to maintain a little extra for future claims (or past claims that exceed the amount estimated) even though this is not required. However, the $45.9 million far exceeds what is reasonable for this purpose, particularly given the current human needs of the community. It approximates 124% of the amount required and already recorded for past claims. In addition, if Diocesan premises are really worth $2.6 billion, why isn't the diocese "unlocking" some of this value now to alleviate the human needs and suffering that exist or to use as an additional insurance reserve if the Diocese really believes one is needed?

Finance Council Criticism: The Administrative Office maintains a $21.3 million "mission fund", which is needed to provide assistance to struggling parishes:

My Response: It's wonderful that the Diocese has a fund available to assist needy parishes. However, at the rate of past assistance provided by the Diocese to needy parishes, this fund is equivalent to six year's worth of future assistance. Perhaps the Diocese should be doing more now to relieve the strain the parishes feel instead of reserving so much of this assistance for the future.

Finance Council Criticism: The Administrative Office also maintains a $39.3 million "quasi-endowment fund", which constitutes "true general reserves" used to balance the annual operating budget and for contingencies:

My Response: It's nice to have an endowment fund. Unfortunately, very little of this fund is being used for current needs. How is a fair, reasonable and responsible balance maintained between current needs, which this "true general reserve" is available for, and future contingencies? I see no mechanism in place to maintain such a balance and worry that the fund will simply continue to grow at the expense of current human need. In addition, would all the parishioners of the Diocese who have contributed to the accumulation of this fund feel betrayed if they knew that a portion of their contributions intended for current needs were essentially "banked" for future contingencies in this fund?

Finance Council Criticism: The financial condition of the parishes and schools is deteriorating, and Mr. Grafer does not acknowledge these important matters:

My Response: I am well aware of the deteriorating financial condition of the parishes, schools and ministries. My purpose in doing the analysis was to demonstrate that the Diocese could afford to do more than it is doing to alleviate these conditions. Even if the free reserves are only "adequate", as the Chairman of the Finance Council now admits, the Diocese has the means to relieve the strain being felt throughout the Diocese. It only lacks the will. (Note: The "means", or "free cash reserves", have actually increased from 8/31/02, the date of my analysis, to 8/31/03, the date of the most recently published Diocesan financial statements, due to market gains realized by the various Diocesan funds. I suspect they have further increased to 8/31/04 although no financial statements as of that date have yet been published)

Finance Council Criticism: Mr. Grafer brought his concerns to the Diocese last fall and we addressed them in detail at that time. Now he repeats his erroneous allegations publicly at the height of our annual appeal, arguing irresponsibly that the Diocese does not require further support:

My Response: This is simply not true. The Diocese discontinued its dialogue with me in October after I sent its Controller (with a copy to the Bishop) a letter asking further questions and making certain recommendations. Thus, my concerns were clearly not "addressed…in detail" at that time, and the Diocese is responsible for terminating the discussions. I waited a few months for a response from the Diocese. When it was clear there would be no response, I gave my analysis to LIVOTF, which then released it to the New York Times. The timing was not contrived as the Council suggests. But, that's not terribly relevant. What is relevant is that the Diocese has the means to provide greater support to those in need in our community. Instead, it continues to build reserves while mandating balanced budget protocols for its various ministries.

Finance Council Criticism: We consider the reserves "adequate", but "are we being conservative enough"?:

My Response: If the Finance Council Members are concerned about whether they're being conservative enough, I'm afraid they've lost touch with reality. Have we ever seen so much need and suffering in our community? Even if my analysis is only half right, the Diocese still has the means to alleviate some of this suffering with its "adequate" free reserves. The problem is that the Bishop believes that under Canon Law he must abdicate responsibility for these free reserves to the Finance Council, and Council Members naturally will never believe they have enough reserves regardless of whether such reserves are merely "adequate", as the Chairman of the Council now admits, or very conservative, as I continue to believe. Thus, we need a mechanism to rein-in the natural conservatism of the Finance Council and provide more current support for those in need. The Diocese seems to be missing this point. It is critical that the rest of us don't.

H. RICHARD GRAFER

DIOCESE OF ROCKVILLE CENTRE ("DRVC")-SPECIFIC METHODOLOGY USED TO CALCULATE "FREE CASH RESERVES"

Cash, cash equivalents, investments and marketable securities, including amounts invested in the diocesan deposit and loan account

Less: All restricted investments included in the above amount

Less: The diocesan deposit and loan account liability, which represents amounts deposited by parishes and ministries with the DRVC for inclusion in the diocesan deposit and loan account but owed back to such depositors

Less: Any other restricted net assets (Theory of this step: Since this is a small amount and it is not clear what such restricted net assets consist of, it is assumed in order to be conservative that such restricted net assets consist of cash included in the above cash amount; therefore, under this assumption they must be deducted in the calculation of "Free Cash Reserves" since they are assumed to be restricted)

RESULT: Unrestricted cash, cash equivalents, investments and marketable securities

Final step: Compare the RESULT above to unrestricted net assets entity by entity. Take the lesser of the RESULT or the unrestricted net assets entity by entity and then combine the amounts "taken" for all entities. This combined amount represents "Free Cash Reserves" for the entire DRVC (Theory of this step: If unrestricted net assets for a particular entity are less than the RESULT for such entity, it means that such entity's unrestricted assets exclusive of cash are less than such entity's unrestricted liabilities. Therefore, the entity has a net liability position exclusive of cash, and the unrestricted cash RESULT must be reduced by such net liability to derive "Free Cash Reserves". Taking the lower of the RESULT and unrestricted net assets effectively accomplishes this reduction)

HISTORY AND BACKGROUND
1. Spring 2003---First publication of financial statements by the DRVC (unconsolidated)
2. August 2003---Completion of first analysis of financials ($119.4 million of free cash reserves) and exchange of letters with DRVC
3. October 2003---Presentation of results to local parish voice
4. March 2004---Publication of results in The New York Times
5. April 2004---Publication in Long Island Catholic of the Finance Council rebuttal
6. Spring 2004---Second year publication of unconsolidated financials by the DRVC
7. October 2004---Completion of my second analysis using refined methodology ($180.1 million of free cash reserves)
8. November 2004---Sent results of second analysis to the Bishop; no response received yet

METHODOLOGY USED

1. Free cash reserves = cash plus marketable securities minus the related deposit and loan account liability (owed to participants) and minus restricted investments and other restricted net assets.
2. It is equivalent to all your "liquid" (non-real estate) savings less all net liabilities, including projected unfunded retirement costs and tuition costs
3. "Designated" vs. "Undesignated" reserves---Designation is discretionary and not required by generally accepted accounting principles ("GAAP"); DRVC designations are quite vague, non-specific, unquantified and general
4. Major components:

1. Administrative Offices = $53.5 million; $24 million of this (the "mission component") is designated for future parish assistance, and $29.5 million consists of a "quasi-endowment fund"
2. Protected Self-Insurance Fund = $52.5 million consisting of reserves on top of reserves for events beyond what the independent actuary and auditor believe is necessary
3. Medical Insurance Fund = $4.6 million consisting of reserves on top of reserves for claims beyond what the independent administrator believes is necessary
4. Catholic Cemeteries = $44.6 million consisting of reserves designated for future maintenance costs over and above the amount required by GAAP.
5. Catholic Charities = $19 million consisting of an amount designated for Catholic Charities Support Corporation (?)
6. Other Diocesan Entities = $5.9 million, half of which is undesignated

CONCLUSIONS

1. "Some" free cash reserves are prudent---The Not-For-Profit Industry norm = 6-12 months of operating expenses
2. DRVC may need a little more due to litigation costs (in excess of the Uninsured Perils Fund $10.9 million)
3. However, DRVC free cash reserves are 3.8 years of "defined" operating expenses (expenses not supported by other sources of revenue)
4. Draw your own conclusion, but I believe 3.8 years is well in excess of "prudence" given the humanitarian and spiritual mission of the DRVC

REMAINING QUESTIONS

1. Does the DRVC have a mechanism to balance current human needs with future contingent needs?
2. The Finance Council agrees that reserves are now "adequate". Then why not segregate future reserve increases and use for high priority humanitarian projects or even dip into these reserves a little now when needs are so great?
3. Does the DRVC have any specific guidelines to determine when reserves become excessive?
4. Why doesn't the DRVC publish combined (consolidated) financial statements, which would provide an overall picture of DRVC financial condition? Is it hiding something?
5. If $180.1 million of free cash reserves is not enough, then HOW MUCH IS ENOUGH?