CSX » Topics » Pension and Post-retirement Medical Plan Accounting

This excerpt taken from the CSX 10-K filed Feb 15, 2007.

Pension and Post-retirement Medical Plan Accounting

The Company sponsors defined benefit pension plans principally for salaried, management personnel. The plans provide eligible employees with retirement benefits based predominantly on years of service and compensation rates near retirement. Employees hired after December 31, 2002 are covered by a cash balance plan, which provides benefits by utilizing interest and pay credits based upon age, service, and compensation.

In addition to these plans, CSX sponsors one post-retirement medical plan and one life insurance plan that provide benefits to full-time, salaried, management employees hired prior to January 1, 2003, upon their retirement if certain eligibility requirements are met. The post-retirement medical plan is contributory (partially funded by retirees), with retiree contributions adjusted annually. The life insurance plan is non-contributory.

The accounting for these plans is subject to the guidance provided in SFAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132 (R) (“SFAS 158”), SFAS 87, Employers Accounting for Pensions

 

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(“SFAS 87”), and SFAS 106, Employers’ Accounting for Postretirement Benefits Other than Pension (“SFAS 106”).

SFAS 87 requires that management make certain assumptions relating to the following:

 

 

 

Long-term rate of return on plan assets;

 

 

 

Discount rates used to measure future obligations and interest expense;

 

 

 

Salary scale inflation rates;

 

 

 

Health care cost trend rates; and

 

 

 

Other assumptions.

These assumptions are determined as of the beginning of the year. As permitted by SFAS 87, the Company has elected to use a plan measurement date of September 30 to actuarially value its pension and post-retirement plans. As required by SFAS 158, CSX will change its measurement date to the fiscal year end in 2008. The Company engages independent, external actuaries to compute the amounts of liabilities and expenses relating to these plans subject to the assumptions that the Company selects as of the beginning of the plan year. The Company reviews the long-term rate of return, discount, salary scale inflation, and health care cost trend rates on an annual basis and makes modifications to the assumptions based on current rates and trends as appropriate.

In September 2006, FASB issued SFAS 158, which changed the accounting rules for reporting and disclosures related to pension and other post-retirement benefit plans. Companies are now required to include on the balance sheet an additional asset or liability to reflect the funded status of retirement and other post-retirement benefit plans, and a corresponding after-tax adjustment to equity. Retroactive application of this accounting rule is prohibited; therefore, 2006 is presented as required by SFAS 158 and 2005 is presented as required under the accounting rules prior to SFAS 158. The adoption in 2006 had no effect on the computation of net periodic benefit expense for pensions and post-retirement benefits. See Note 8, Employee Benefit Plans, for the impact on the consolidated balance sheet. Effective 2008, CSX will be required to change the measurement date for post-retirement benefit plans from September 30 to the last day of the fiscal year.

Long-term Rate of Return on Plan Assets

The expected long-term rate of return on plan assets reflects the average rate of earnings expected on the funds invested, or to be invested, to provide for benefits included in the projected benefit obligation. In estimating that rate, the Company gives appropriate consideration to the returns being earned by the plan assets in the funds and the rates of return expected to be available for reinvestment.

The Company’s expected long-term average rate of return on assets considers the current and projected asset mix of the funds. Management balances market expectations obtained from various investment managers and economists with both market and actual plan historical returns to develop a reasonable estimate of the expected long-term rate of return on assets. As this assumption is long-term, it is adjusted less frequently than other assumptions used in pension accounting. The long-term rate of return on plan assets used by the Company to value its 2006 pension obligation was 8.5%.

Discount Rates

Discount rates affect the amount of liability recorded and the interest expense component of pension and post-retirement expense. Assumed discount rates reflect the rates at which both of these

 

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benefits could be effectively settled. It is appropriate in estimating those rates to look to available information about rates implicit in current prices of annuity contracts that could be used to settle these obligations. In making those estimates, employers may also look to rates of return on high quality fixed-income investments currently available and expected to be available, during the period to maturity of the pension benefits. The Company determines the discount rate based on a hypothetical portfolio of high quality bonds with cash flows matching the plans’ expected benefit payments. The discount rates used by the Company to value its 2006 pension and post-retirement obligations are 5.75% and 5.5%, respectively. The Company uses a different discount rate for pension and post-retirement benefits due to the different time horizons of future payments for each of the plans. For pensions, the time horizon is approximately 12 years, while for post-retirement, the time horizon is approximately 8 years.

Each year these discount rates are reevaluated and adjusted to reflect the best estimate of the current effective settlement rates. If interest rates generally decline or rise, the assumed discount rates will change.

Salary Scale Inflation Rates

Salary scale inflation rates are based on current trends and historical data accumulated by the Company. The Company reviews recent wage increases and management incentive compensation payments over the past five years in its assessment of salary scale inflation rates. The Company used a salary scale rate of 4.1% to value its 2006 pension obligation.

Health Care Cost Trend Rates

Health care cost trend rates are based on recent plan experience and industry trends. The Company uses actuarial data to substantiate the inflation assumption for health care costs, representing increases in total plan costs (which include claims and administrative fee cost components). The current assumed health care cost trend rate is 10% for Medicare-eligible participants and 11% for non-Medicare-eligible participants, and is expected to decrease gradually until reaching 4.5% in 2014, based upon current actuarial projections.

Other Assumptions

The calculations made by the actuaries also include assumptions relating to mortality rates, turnover and retirement age. These assumptions are based upon historical data and are approved by management.

2007 Estimated Pension and Post-retirement Expense

Net periodic pension and post-retirement benefits expense for 2007 is expected to be approximately $54 million and $25 million, respectively, compared to $62 million and $30 million, respectively in 2006.

The following sensitivity analysis illustrates the effect of changes in certain assumptions like discount rates, salaries, and health care costs on the 2007 estimated pension and post-retirement expense:

 

(Dollars in Millions)

   Pension    OPEB

Discount Rate 0.25% change

   $ 4    $ 2

Salary Inflation 0.25% change

     3     

Health Care Cost 1% change

     N/A      2

 

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The discount rate for pension and post-retirement plans has an inverse relationship with the expense calculation, meaning that as the discount rate increases, expense decreases and vice versa. The other assumptions above have a direct relationship with expense.

Pension Protection Act

In August 2006, the President of the United States signed the Pension Protection Act of 2006 into law. Included in this legislation are changes to the method of valuing pension plan assets and liabilities for funding purposes, as well as the minimum funding levels required by 2008. CSX is determining what impact the new requirements will have on the Company’s cash flow; however, initial estimates forecast a 2008 unfunded liability of approximately $185 million after tax. This estimate will be affected by future contributions, investment returns on plan assets and interest rates. Under the transition rules provided, CSX must begin the funding of this 2008 shortfall no later than 2009, and must complete the funding by 2014. The Company anticipates funding pension contributions with cash from operations.

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