BAX » Topics » Pension and Other Postemployment Benefit Plans

This excerpt taken from the BAX 10-K filed Feb 28, 2007.
Pension and Other Postemployment Benefit Plans
The company provides pension and other postemployment benefits to certain of its employees. These employee benefit expenses are reported in the same line items in the consolidated income statement as the applicable employee’s compensation expense. The valuation of the funded status and net benefit cost for the plans are calculated using actuarial assumptions. These assumptions are reviewed annually, and revised if appropriate. The significant assumptions include the following:
 
  •  interest rates used to discount pension and OPEB plan liabilities;
 
  •  the long-term rate of return on pension plan assets;
 
  •  rates of increases in employee compensation (used in estimating liabilities);
 
  •  anticipated future healthcare costs (used in estimating the OPEB plan liability); and
 
  •  other assumptions involving demographic factors such as retirement, mortality and turnover (used in estimating liabilities).


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MANAGEMENT’S DISCUSSION and ANALYSIS
 
Selecting assumptions involves an analysis of both short-term and long-term historical trends and known economic and market conditions at the time of the valuation (also called the measurement date). The use of different assumptions would result in different measures of the funded status and net cost. Actual results in the future could differ from expected results. Management is not able to estimate the probability of actual results differing from expected results, but believes its assumptions are appropriate.
 
The company’s key assumptions are listed in Note 8. The most critical assumptions relate to the plans covering U.S. and Puerto Rico employees, because these plans are the most significant to the company’s consolidated financial statements.
 
Discount Rate Assumption
For the U.S. and Puerto Rico plans, the company used a discount rate of 6.0% to measure its benefit obligations under the pension and OPEB plans at the measurement date (September 30, 2006). This assumption will be used in calculating the net periodic benefit cost for these plans for 2007. Management used a broad population of approximately 300 Aa-rated corporate bonds as of September 30, 2006 to determine the discount rate assumption. All bonds were U.S. issues, with a minimum amount outstanding of $50 million. This population of bonds was narrowed from a broader universe of over 550 Moody’s Aa rated, non-callable (or callable with make-whole provisions) bonds by eliminating the top and bottom 10th percentile to adjust for any pricing anomalies, and then selecting the bonds Baxter would most likely select if it were to actually annuitize its pension and OPEB liabilities. This portfolio of bonds was used to generate a yield curve and associated spot rate curve, to discount the projected benefit payments for the U.S. and Puerto Rico plans. The discount rate is the single level rate that produces the same result as the spot rate curve. The discount rate generated from this analysis was 6.0%.
 
For the company’s international plans, the discount rate is determined by reviewing country- and region-specific government and corporate bond interest rates.
 
In order to understand the impact of changes in discount rates on pension and OPEB cost, management performs a sensitivity analysis. Holding all other assumptions constant, for each 50 basis point (i.e., one-half of one percent) increase (decrease) in the discount rate, global pre-tax pension and OPEB plan cost would decrease (increase) by approximately $34 million.
 
Return on Plan Assets Assumption
In measuring net periodic cost for 2006, the company used a long-term expected rate of return of 8.5% for the pension plans covering U.S. and Puerto Rico employees. This is consistent with the assumption used in measuring the 2005 pension cost and will be used to measure net pension cost for 2007. This assumption is not applicable to the company’s OPEB plans because they are not funded. Management establishes the long-term asset return assumption based on a review of historical compound average asset returns, both company-specific and relating to the broad market (based on the company’s asset allocation), as well as an analysis of current market information and future expectations. The current asset return assumption is supported by historical market experience. In calculating net pension cost, the expected return on assets is applied to a calculated value of plan assets, which recognizes changes in the fair value of plan assets in a systematic manner over five years. The difference between this expected return and the actual return on plan assets is a component of the total net unrecognized gain or loss and is subject to amortization in the future. In order to understand the impact of changes in the expected asset return assumption on net cost, management performs a sensitivity analysis. Holding all other assumptions constant, for each 50 basis point increase (decrease) in the asset return assumption, global pre-tax pension plan cost would decrease (increase) by approximately $12 million.
 
Other Assumptions
Published mortality tables are used in calculating pension and OPEB plan benefit obligations. At the end of 2005, management changed the mortality tables it uses for certain of the company’s plans, and now uses tables that are based on more current experience. Specifically, for the company’s U.S. and Puerto Rico plans, management changed from the 1983 Group Annuity Mortality table to the Retirement Plan 2000 table. Management believes the Retirement Plan 2000 table better predicts future mortality experience for the participants included in Baxter’s plans. The change in mortality tables increased net pension and OPEB plan cost by approximately $12 million in 2006.
 
The assumptions relating to employee compensation increases and future healthcare costs are based on historical experience, market trends, and anticipated future management actions. Refer to Note 8 for information regarding the sensitivity of the OPEB plan obligation and the total of the service and interest cost components of OPEB plan cost to potential changes in future healthcare costs.


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MANAGEMENT’S DISCUSSION and ANALYSIS
 
This excerpt taken from the BAX 10-K filed Mar 7, 2006.
Pension and Other Postemployment Benefit Plans
The company provides pension benefits and other postemployment benefits (OPEB) to certain of its employees. These employee benefit expenses are reported in the same line items in the consolidated income statement as the applicable employee’s compensation expense. The valuation of the funded status and net expense for the plans are calculated using actuarial assumptions. These assumptions are reviewed annually, and revised if appropriate. The significant assumptions include the following:

  •  interest rates used to discount pension and OPEB plan liabilities;
 
  •  the long-term rate of return on pension plan assets;
 
  •  rates of increases in employee compensation (used in estimating liabilities);
 
  •  anticipated future healthcare costs (used in estimating the OPEB plan liability); and
 
  •  other assumptions involving demographic factors such as retirement, mortality and turnover (used in estimating liabilities).

Selecting assumptions involves an analysis of both short-term and long-term historical trends and known economic and market conditions at the time of the valuation (also called the measurement date). The use of different assumptions would result in different measures of the funded status and net expense. Actual results in the future could differ from expected results. Management is not able to estimate the probability of actual results differing from expected results, but believes its assumptions are appropriate.

The company’s assumptions are listed in Note 7. The most critical assumptions relate to the plans covering U.S. and Puerto Rican employees, because these plans are the most significant to the company’s consolidated financial statements.

Discount Rate Assumption

For the U.S. and Puerto Rico plans, the company used a discount rate of 5.75% for both the pension and OPEB plans, the same as in the prior year. This 2005 measurement date assumption will be used in calculating the expense for these plans in 2006.

Management refined its methodology for determining the discount rate assumption in 2005, and believes the new methodology is preferable because it results in a more appropriate discount rate assumption. In prior years, the company primarily used the Moody’s Aa corporate bond index, and adjusted for differences in duration between the bonds in the index and Baxter’s pension and OPEB plan liabilities (incorporating expected reinvestment rates, which were extrapolated from the measurement-date yield curve). As of the 2005 measurement date, management used a broader population of approximately 300 Aa-rated corporate bonds

 
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MANAGEMENT’S DISCUSSION AND ANALYSIS

as of September 30, 2005. This population of bonds was narrowed from a broader universe of over 550 Moody’s Aa rated, non-callable (or callable with make-whole provisions) bonds. All bonds were U.S. issues, with a minimum amount outstanding of $50 million. The approximately 300 bonds used to determine Baxter’s discount rate assumption were selected from the broader universe by eliminating the top and bottom 10th percentile to adjust for any pricing anomalies, and then selecting the bonds Baxter would most likely select if it were to actually annuitize its pension and OPEB liabilities. This portfolio of bonds was used to generate a yield curve and associated spot rate curve, to discount the projected benefit payments for the U.S. and Puerto Rico plans. The discount rate is the single level rate that produces the same result as the spot rate curve. The discount rate generated from this analysis was 5.75%.

In order to understand the impact of changes in discount rates on expense, management performs a sensitivity analysis. Holding all other assumptions constant, for each 50 basis point (i.e., one-half of one percent) increase (decrease) in the discount rate, global pre-tax pension and OPEB plan expenses would decrease (increase) by approximately $28 million.

Return on Plan Assets Assumption

As of the 2005 measurement date, the company is using a long-term rate of return of 8.5% for the pension plans covering U.S. and Puerto Rican employees, the same as in the prior year (this assumption is not applicable to the company’s OPEB plans because they are not funded). The 8.5% assumption will be used in calculating net pension expense for 2006.

Management reduced the expected asset return assumption in 2005, from 10% in 2004 to 8.5% in 2005, primarily due to anticipated changes in the company’s pension trust asset allocation. The company is reducing the equity securities weighting in the overall asset portfolio over time, and increasing the portion of the portfolio invested in fixed-income securities. Based on historical and projected analyses, fixed-income securities generate lower returns over time than equity securities. The lower return associated with fixed-income securities is offset by generally lower risk and other benefits relating to investing in these securities. Refer to Note 7 for the company’s targeted asset allocation ranges and actual asset allocations at the 2005 and 2004 pension plan measurement dates, as well as a summary of the company’s policies and procedures relating to its pension plan assets. While there are market volatility risks associated with the trust portfolio, which remains heavily weighted in equity securities, management believes the allocation is reasonable and appropriate based on risk management analyses, the duration of the pension plan obligations, and other factors.

Management establishes the long-term asset return assumption based on a review of historical compound average asset returns, both company-specific and relating to the broad market (based on the company’s asset allocation), as well as an analysis of current market information and future expectations. The current asset return assumption is supported by historical market experience. In each of 2005, 2004 and 2003 (as well as in longer historical periods), the actual returns on the pension trust assets have exceeded the asset return assumption. Actual asset returns on the company’s primary pension trust relating to the U.S. and Puerto Rico plans were approximately 16% in 2005, 13% in 2004 and 14% in 2003.

In calculating net pension expense, the expected return on assets is applied to a calculated value of plan assets, which recognizes changes in the fair value of plan assets in a systematic manner over five years. The difference between this expected return and the actual return on plan assets is a component of the total net unrecognized gain or loss and is subject to amortization in the future.

In order to understand the impact of changes in the expected asset return assumption on net expense, management performs a sensitivity analysis. Holding all other assumptions constant, for each 50 basis point increase (decrease) in the asset return assumption, global pre-tax pension plan expenses would decrease (increase) by approximately $10 million.

Other Assumptions

Published mortality tables are used in calculating pension and OPEB plan benefit obligations. In 2005, management changed the mortality tables it uses for certain of the company’s plans, and now uses tables that are based on more current experience. Specifically, for the company’s U.S. and Puerto Rico plans, management changed from the 1983 Group Annuity Mortality table to the Retirement Plan 2000 table. Management believes the Retirement Plan 2000 table will better predict future mortality
 
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MANAGEMENT’S DISCUSSION AND ANALYSIS

experience for the participants included in Baxter’s plans. Management estimates that the change in mortality tables as of the September 30, 2005 measurement date will result in an increase in the benefit obligation of approximately $65 million and an increase in 2006 pre-tax global net pension and OPEB plan expense of approximately $12 million.

The assumptions relating to employee compensation increases and future healthcare costs are based on historical experience, market trends, and anticipated future management actions. Refer to Note 7 for information regarding the sensitivity of the OPEB plan obligation and the total of the service and interest cost components of OPEB plan expense to potential changes in future healthcare costs.

Projected 2006 Pension and OPEB Plan Expense

Overall, total expense for the company’s pension and OPEB plans is expected to increase by approximately $26 million, from $196 million in 2005 to approximately $222 million in 2006, principally related to the company’s pension plans.

The expected $26 million increase is principally due to changes in assumptions (including the $12 million impact of the change in mortality tables) and demographics, partially offset by higher expected investment returns relating to the company’s $574 million funding of its plans during 2005. In addition, pension and OPEB plan expense fluctuates each year based on the normal operation of the plans.

Amortization of Gains and Losses and Changes in Assumptions

As disclosed in Note 7, the company’s benefit plans had a net unrecognized loss of $1.5 billion as of the 2005 measurement date. Gains and losses resulting from actual experience differing from assumptions are determined on each measurement date, and are subject to recognition in the consolidated income statement. These calculated gains and losses are also impacted by any changes in assumptions during the year. If the net accumulated gain or loss exceeds 10% of the greater of plan assets or liabilities, a portion of the net unrecognized gain or loss is amortized to income or expense over the remaining service lives of employees participating in the plans, beginning in the following year. Amortization of the net unrecognized loss, which is a component of total pension and OPEB plan expense, increased in both 2005 and 2004, as detailed in Note 7. The increased loss amortization component of total pension and OPEB plan expense was partly impacted by changes in the discount rate and investment return assumptions over the three-year period. It should be noted that changes in assumptions do not directly impact the company’s cash flows as funding requirements are pursuant to government regulations, which use different formulas and assumptions than GAAP (refer to the Funding of Pension and OPEB Plans section below).

The company will evaluate the assumptions as of the 2006 measurement date based on market conditions and future expectations, which may result in changes to the assumptions at that time.

EXCERPTS ON THIS PAGE:

10-K
Feb 28, 2007
10-K
Mar 7, 2006
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