Note 9 — Pension and Other Postretirement Benefit Plans
The Company and certain of its subsidiaries provide pension, health care and life insurance defined benefits to eligible retired employees, spouses and other eligible dependents through various domestic and foreign plans. The effect of its foreign pension and other postretirement benefit plans is immaterial to the Company's results of operations, liquidity and financial position. Effective July 1, 2009, the Company froze its primary domestic defined benefit pension plans.
During the first quarter of 2013, the Company announced two changes to its postretirement medical plan:
The Company measures the assets and liabilities of its domestic pension and other postretirement benefit plans as of December 31. The following table summarizes the projected benefit obligations and assets related to the Company's domestic and international pension and other postretirement benefit plans as of, and for the year ended, December 31:
| Pension | Other Postretirement | |||||||
| Benefits | Benefits | |||||||
| (In millions) | 2013 | 2012 | 2013 | 2012 | ||||
| Change in benefit obligation | ||||||||
| Benefit obligation, January 1 | $ | 5,267 | $ | 5,067 | $ | 442 | $ | 452 |
| Service cost | 3 | 3 | 1 | 2 | ||||
| Interest cost | 181 | 198 | 12 | 16 | ||||
| (Gain) loss from past experience | (464) | 283 | (37) | (2) | ||||
| Effect of plan amendment | - | - | (57) | - | ||||
| Benefits paid from plan assets | (262) | (256) | (3) | (3) | ||||
| Benefits paid - other | (25) | (28) | (28) | (23) | ||||
| Curtailment | - | - | (7) | - | ||||
| Benefit obligation, December 31 | 4,700 | 5,267 | 323 | 442 | ||||
| Change in plan assets | ||||||||
| Fair value of plan assets, January 1 | 3,665 | 3,298 | 20 | 22 | ||||
| Actual return on plan assets | 488 | 370 | (1) | 1 | ||||
| Benefits paid | (262) | (256) | (3) | (3) | ||||
| Contributions | 198 | 253 | - | - | ||||
| Fair value of plan assets, December 31 | 4,089 | 3,665 | 16 | 20 | ||||
| Funded Status | $ | (611) | $ | (1,602) | $ | (307) | $ | (422) |
The postretirement benefits liability adjustment included in accumulated other comprehensive loss consisted of the following as of December 31:
| Pension | Other | |||||||
| Benefits | Postretirement Benefits | |||||||
| (In millions) | 2013 | 2012 | 2013 | 2012 | ||||
| Unrecognized net gain (loss) | $ | (1,696) | $ | (2,450) | $ | 14 | $ | (28) |
| Unrecognized prior service cost | (5) | (5) | 57 | 23 | ||||
| Postretirement benefits liability adjustment | $ | (1,701) | $ | (2,455) | $ | 71 | $ | (5) |
During 2013, the Company's postretirement benefits liability adjustment decreased by $830 million pre-tax ($539 million after-tax) resulting in an increase to shareholders' equity. The decrease in the liability was primarily due to an increase in the discount rate, actual investment returns greater than expected in 2013, the effect of the plan amendment described above, and amortization.
Pension benefits. The Company's pension plans were underfunded by $0.6 billion in 2013 and $1.6 billion in 2012 and had related accumulated benefit obligations of $4.7 billion as of December 31, 2013 and $5.3 billion as of December 31, 2012.
The Company funds its qualified pension plans at least at the minimum amount required by the Employee Retirement Income Security Act of 1974 and the Pension Protection Act of 2006. For 2014, the Company expects to make minimum required contributions totaling approximately $100 million. Future years' contributions will ultimately be based on a wide range of factors including but not limited to asset returns, discount rates, and funding targets.
Components of net pension cost for the years ended December 31 were as follows:
| (In millions) | 2013 | 2012 | 2011 | |||
| Service cost | $ | 3 | $ | 3 | $ | 2 |
| Interest cost | 181 | 198 | 228 | |||
| Expected long-term return on plan assets | (272) | (270) | (267) | |||
| Amortization of: | ||||||
| Net loss from past experience | 74 | 58 | 38 | |||
| Settlement loss | - | 6 | - | |||
| Net pension cost | $ | (14) | $ | (5) | $ | 1 |
The Company expects to recognize pre-tax losses of $57 million in 2014 from amortization of past experience. This estimate is based on a weighted average amortization period for the frozen and inactive plans that is based on the average expected remaining life of plan participants of approximately 28 years.
Other postretirement benefits. Unfunded retiree health benefit plans had accumulated benefit obligations of $190 million at December 31, 2013 and $294 million at December 31, 2012. Retiree life insurance plans had accumulated benefit obligations of $133 million as of December 31, 2013 and $148 million as of December 31, 2012.
Components of net other postretirement benefit cost for the years ended December 31 were as follows:
| (In millions) | 2013 | 2012 | 2011 | |||
| Service cost | $ | 1 | $ | 2 | $ | 2 |
| Interest cost | 12 | 16 | 20 | |||
| Expected long-term return on plan assets | (1) | (1) | (1) | |||
| Amortization of: | ||||||
| Prior service cost | (4) | (12) | (16) | |||
| Curtailment gain | (19) | - | - | |||
| Net other postretirement benefit cost | $ | (11) | $ | 5 | $ | 5 |
The Company expects to recognize immaterial pre-tax gains related to amortization of prior service cost and no pre-tax gains from amortization of past experience in 2014. The amortization period is based on an average expected remaining life of plan participants of 28 years.
The estimated rate of future increases in the per capita cost of health care benefits is 7% in 2014, decreasing by 0.5% per year to 5% in 2018 and beyond. This estimate reflects the Company's current claim experience and management's estimate that rates of growth will decline in the future. A 1% increase or decrease in the estimated rate would have changed 2013 reported amounts as follows:
| (In millions) | Increase | Decrease | ||
| Effect on total service and interest cost | $ | - | $ | - |
| Effect on postretirement benefit obligation | $ | 3 | $ | - |
Plan assets. The Company's current target investment allocation percentages (50% fixed income, 25% equity securities, 11% securities partnerships, 7% hedge funds and 7% real estate) are developed by management as guidelines, although the fair values of each asset category are expected to vary as a result of changes in market conditions. As funding levels improved during 2013, the Company gradually reduced its allocation to equity securities and moved into fixed income to mitigate some of the volatility in returns. As the funding level continues to improve, the Company would expect to further reduce the allocation to equity securities and move further into fixed income investments. Although it has decreased its allocation to equity securities in 2013, the pension plan asset portfolio continues to include a 29% allocation of equity securities, consisting of domestic and international investments, in an effort to achieve a higher rate of return on pension plan investments over the long-term payout period of the pension benefit obligations.
As of December 31, 2013, pension plan assets included $3.8 billion invested in the separate accounts of Connecticut General Life Insurance Company (“CGLIC”) and Life Insurance Company of North America, that are subsidiaries of the Company, as well as an additional $245 million invested directly in funds offered by the buyer of the retirement benefits business.
The fair values of plan assets by category and by the fair value hierarchy as defined by GAAP are as follows. See Note 10 for a description of how fair value is determined, including the level within the fair value hierarchy and the procedures the Company uses to validate fair value measurements.
| December 31, 2013 | ||||||||
| (In millions) | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total | ||||
| Plan assets at fair value: | ||||||||
| Fixed maturities: | ||||||||
| Federal government and agency | $ | - | $ | 2 | $ | - | $ | 2 |
| Corporate | - | 725 | 24 | 749 | ||||
| Mortgage and other asset-backed | - | 18 | 5 | 23 | ||||
| Fund investments and pooled separate accounts (1) | - | 1,019 | 3 | 1,022 | ||||
| Total fixed maturities | - | 1,764 | 32 | 1,796 | ||||
| Equity securities: | ||||||||
| Domestic | 824 | - | 35 | 859 | ||||
| International, including funds and pooled separate accounts (1) | 187 | 124 | 7 | 318 | ||||
| Total equity securities | 1,011 | 124 | 42 | 1,177 | ||||
| Real estate and mortgage loans, including pooled separate accounts (1) | - | - | 339 | 339 | ||||
| Securities partnerships | - | - | 304 | 304 | ||||
| Hedge funds | - | - | 360 | 360 | ||||
| Guaranteed deposit account contract | - | - | 44 | 44 | ||||
| Cash equivalents | - | 69 | - | 69 | ||||
| Total plan assets at fair value | $ | 1,011 | $ | 1,957 | $ | 1,121 | $ | 4,089 |
| (1) A pooled separate account has several participating benefit plans and each owns a share of the total pool of investments. | ||||||||
| December 31, 2012 | ||||||||
| (In millions) | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total | ||||
| Plan assets at fair value: | ||||||||
| Fixed maturities: | ||||||||
| Federal government and agency | $ | - | $ | 4 | $ | - | $ | 4 |
| Corporate | - | 416 | 27 | 443 | ||||
| Mortgage and other asset-backed | - | 8 | 5 | 13 | ||||
| Fund investments and pooled separate accounts (1) | - | 519 | 3 | 522 | ||||
| Total fixed maturities | - | 947 | 35 | 982 | ||||
| Equity securities: | ||||||||
| Domestic | 1,202 | 4 | 10 | 1,216 | ||||
| International, including funds and pooled separate accounts (1) | 158 | 149 | - | 307 | ||||
| Total equity securities | 1,360 | 153 | 10 | 1,523 | ||||
| Real estate and mortgage loans, including pooled separate accounts (1) | - | - | 351 | 351 | ||||
| Securities partnerships | - | - | 328 | 328 | ||||
| Hedge Funds | - | - | 327 | 327 | ||||
| Guaranteed deposit account contract | - | - | 47 | 47 | ||||
| Cash equivalents | - | 107 | - | 107 | ||||
| Total plan assets at fair value | $ | 1,360 | $ | 1,207 | $ | 1,098 | $ | 3,665 |
| (1) A pooled separate account has several participating benefit plans and each owns a share of the total pool of investments. | ||||||||
Plan assets in Level 1 include exchange-listed equity securities. Level 2 assets primarily include:
Plan assets classified in Level 3 include investments primarily in securities partnerships, equity real estate and hedge funds generally valued based on the pension plan's ownership share of the equity of the investee including changes in the fair values of its underlying investments.
The following table summarizes the changes in pension plan assets classified in Level 3 for the years ended December 31, 2013 and December 31, 2012. Actual return on plan assets in this table may include changes in fair value that are attributable to both observable and unobservable inputs.
| (In millions) | Fixed Maturities & Equity Securities | Real Estate & Mortgage Loans | Securities Partnerships | Hedge Funds | Guaranteed Deposit Account Contract | Total | ||||||
| Balance at January 1, 2013 | $ | 44 | $ | 352 | $ | 328 | $ | 327 | $ | 47 | $ | 1,098 |
| Actual return on plan assets: | ||||||||||||
| Assets still held at the reporting date | - | 29 | 16 | 38 | 1 | 84 | ||||||
| Assets sold during the period | 7 | - | - | - | - | 7 | ||||||
| Total actual return on plan assets | 7 | 29 | 16 | 38 | 1 | 91 | ||||||
| Purchases, sales, settlements, net | 25 | (42) | (40) | (5) | (4) | (66) | ||||||
| Transfers into/out of Level 3 | (2) | - | - | - | - | (2) | ||||||
| Balance at December 31, 2013 | $ | 74 | $ | 339 | $ | 304 | $ | 360 | $ | 44 | $ | 1,121 |
| (In millions) | Fixed Maturities & Equity Securities | Real Estate & Mortgage Loans | Securities Partnerships | Hedge Funds | Guaranteed Deposit Account Contract | Total | ||||||
| Balance at January 1, 2012 | $ | 26 | $ | 303 | $ | 314 | $ | 148 | $ | 39 | $ | 830 |
| Actual return on plan assets: | ||||||||||||
| Assets still held at the reporting date | - | 38 | 18 | 10 | 3 | 69 | ||||||
| Assets sold during the period | - | - | - | - | - | - | ||||||
| Total actual return on plan assets | - | 38 | 18 | 10 | 3 | 69 | ||||||
| Purchases, sales, settlements, net | 5 | 11 | (4) | 169 | 5 | 186 | ||||||
| Transfers into/out of Level 3 | 13 | - | - | - | - | 13 | ||||||
| Balance at December 31, 2012 | $ | 44 | $ | 352 | $ | 328 | $ | 327 | $ | 47 | $ | 1,098 |
The assets related to other postretirement benefit plans are invested in deposit funds with interest credited based on fixed income investments in the general account of CGLIC. As there are significant unobservable inputs used in determining the fair value of these assets, they are classified as Level 3. During 2013, these assets had a loss of $1 million, as well as a net withdrawal from the fund of $3 million, while during 2012, they earned a return of $1 million, offset by a net withdrawal of $3 million.
Assumptions for pension and other postretirement benefit plans. Management determined the present value of the projected benefit obligation and the accumulated other postretirement benefit obligation and related benefit costs based on the following weighted average assumptions as of and for the years ended December 31:
| 2013 | 2012 | ||
| Discount rate: | |||
| Pension benefit obligation | 4.50% | 3.50% | |
| Other postretirement benefit obligation | 4.00% | 3.25% | |
| Pension benefit cost | 3.50% | 4.00% | |
| Other postretirement benefit cost | 3.25% | 3.75% | |
| Expected long-term return on plan assets: | |||
| Pension benefit cost | 8.00% | 8.00% | |
| Other postretirement benefit cost | 5.00% | 5.00% |
In measuring the benefit obligation, the Company sets discount rates by applying actual annualized yields at various durations from a discount rate curve to the expected cash flows of the pension and other postretirement benefits liabilities. The discount rate curve is constructed using an array of bonds in various industries throughout the domestic market for high quality bonds, but only selects those for the curve that have an above average return at each duration. The bond portfolio used to construct the curve is monitored to ensure that only high quality issues are included. The Company believes that this curve is representative of the yields that the Company is able to achieve in its plan asset investment strategy. As part of its discount rate setting process, the Company reviewed alternative indices and determined that they were not materially different than the result produced by the curve used.
Expected long-term rates of return on plan assets were developed considering actual long-term historical returns, expected long-term market conditions, plan asset mix and management's investment strategy, that continues a significant allocation to domestic and foreign equity securities as well as real estate, securities partnerships and hedge funds. Expected long-term market conditions take into consideration certain key macroeconomic trends including expected domestic and foreign GDP growth, employment levels and inflation. The expected return assumption is considered reasonable for 2013. The Company will be re-assessing its expected return assumption for 2014 given the change in asset mix that occurred during 2013.
To measure pension costs, the Company uses a market-related asset valuation for domestic pension plan assets invested in non-fixed income investments. The market-related value of these pension assets recognizes the difference between actual and expected long-term returns in the portfolio over 5 years, a method that reduces the short-term impact of market fluctuations on pension cost. At December 31, 2013, the market-related asset value was approximately $3.8 billion compared with a market value of approximately $4.1 billion.
Benefit payments. The following benefit payments, including expected future services, are expected to be paid in:
| Pension | Other Postretirement | |||
| (In millions) | Benefits | Benefits | ||
| 2014 | $ | 417 | $ | 33 |
| 2015 | $ | 336 | $ | 32 |
| 2016 | $ | 335 | $ | 31 |
| 2017 | $ | 335 | $ | 30 |
| 2018 | $ | 334 | $ | 28 |
| 2019-2022 | $ | 1,621 | $ | 117 |
B. 401(k) Plans
The Company sponsors a 401(k) plan in which the Company matches a portion of employees' pre-tax contributions. Another 401(k) plan with an employer match was frozen in 1999. Participants in the active plan may invest in various funds that invest in the Company's common stock, several diversified stock funds, a bond fund or a fixed-income fund. In conjunction with the action to freeze the domestic defined benefit pension plans, effective January 1, 2010, the Company increased its matching contributions to 401(k) plan participants.
The Company may elect to increase its matching contributions if the Company's annual performance meets certain targets. A substantial amount of the Company's matching contributions are invested in the Company's common stock. The Company's expense for these plans was $91 million for 2013, $78 million for 2012 and $72 million for 2011.