Eversource 2002 Annual Report Download - page 29

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The application of SFAS No. 71 results in the deferral of costs as regulatory
assets that, in some cases, have not yet been approved for recovery by the
applicable regulatory commission. Management must conclude that any
costs deferred as regulatory assets are probable of future recovery in rates.
However, regulatory commissions can reach different conclusions about
the recovery of costs, which can have a material impact on NU’s
consolidated financial statements. Management believes it is probable
that NU’s regulated utility companies will recover their investments in
long-lived assets, including regulatory assets.
Goodwill and Other Intangible Assets: On January 1, 2002, NU adopted
SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142
requires that management determine reporting units that carry goodwill.
The determination of reporting units requires judgment based on how the
business segments are managed. SFAS No. 142 also requires that goodwill
and intangible assets deemed to have indefinite useful lives be reviewed
for impairment upon adoption and at least annually thereafter by applying
a fair value-based test. The fair value-based test involves estimating the
fair value of the reporting units by using both discounted cash flow
methodologies and an analysis of comparable companies or transactions.
The discounted cash flow methodologies that are utilized involve critical
assumptions and estimates made by management. If these assumptions
are changed there could be a significant impact on NU’s consolidated
financial statements.
Pension and Postretirement Benefit Obligations: NU’s subsidiaries participate
in a uniform noncontributory defined benefit retirement plan (Plan)
covering substantially all regular NU employees and also provide certain
health care benefits, primarily medical and dental, and life insurance
benefits through a benefit plan to retired employees. For each of these
plans, the development of the benefit obligation, fair value of plan assets,
funded status and net periodic benefit credit or cost is based on several
significant assumptions. If these assumptions were changed, the resultant
change in benefit obligations, fair values of plan assets, funded status and
net periodic benefit credits or costs could have a material impact on NU’s
consolidated financial statements.
Pre-tax periodic pension income for the Plan, excluding settlements,
curtailments, and special termination benefits, totaled $73.4 million and
$101 million for the years ended December 31, 2002 and 2001, respectively.
Pension income is calculated based upon a number of actuarial
assumptions, including an expected long-term rate of return on Plan
assets of 9.25 percent for 2002 and 9.5 percent for 2001. NU expects to
use a long-term rate of return assumption of 8.75 percent for 2003. The
pension income amounts exclude one-time items recorded under SFAS
No. 88, “Employers’Accounting for Settlements and Curtailments of
Defined Benefit Pension Plans and for Termination Benefits,” associated
with early termination programs and the sale of the Millstone and
Seabrook nuclear units. Net SFAS No. 88 items totaled $22.2 million of
income and $2.6 million in expense for the years ended December 31,
2002 and 2001, respectively. Approximately 30 percent of net pension
income is capitalized as a reduction to capital additions to utility plant.
In developing the expected long-term rate of return assumption, NU
evaluated input from actuaries, consultants and economists as well as
long-term inflation assumptions and NU’s historical 20-year compounded
return of 10.7 percent. NU’s expected long-term rate of return on Plan
assets is based on target asset allocation assumptions of 45 percent in
United States equities and 14 percent in non-United States equities, both
with an expected long-term rates of return of 9.25 percent, 3 percent in
emerging market equities with an expected long-term return of 10.25
percent, 20 percent in fixed income securities with an expected long-term
rate of return of 5.5 percent, 5 percent in high yield fixed income securities
with expected long-term rates of return of 7.5 percent, 8 percent in private
equities with expected long-term rates of return of 14.25 percent, and 5
percent in real estate with expected long-term rates of return of 7.5 percent.
The combination of these target allocations and expected returns results
in the overall assumed long-term rate of return of 8.75 percent for 2003.
The actual asset allocation at December 31, 2002, was close to these target
asset allocations, and NU regularly reviews the actual asset allocations
and periodically rebalances the investments to the targeted allocation
when appropriate. NU reduced the long-term rate of return assumption
by 0.5 percent and 0.25 percent, respectively, each of the last two years
due to lower rate of return assumptions for most asset classes. NU believes
that 8.75 percent is a reasonable long-term rate of return on Plan assets
for 2003. NU will continue to evaluate the actuarial assumptions, including
the expected rate of return, at least annually, and will adjust the appropriate
assumptions as necessary.
NU bases the actuarial determination of Plan pension income/expense on
a market-related valuation of assets, which reduces year-to-year volatility.
This market-related valuation recognizes investment gains or losses over
a four-year period from the year in which they occur. Investment gains or
losses for this purpose are the difference between the expected return
calculated using the market-related value of assets and the actual return
based on the fair value of assets. Since the market-related value of assets
recognizes gains or losses over a four-year period, the future value of the
market-related assets will be impacted as previously deferred gains or
losses are recognized. There will be no impact on the fair value of Plan
assets. At December 31, 2002, the Plan had cumulative unrecognized
investment losses of $507.9 million, which will increase pension expense
over the next four years by reducing the expected return on Plan assets.
At December 31, 2002, the Plan also had cumulative unrecognized actuarial
gains of $89 million, which will reduce pension expense over the expected
future working lifetime of active Plan participants, or approximately 13
years. The combined total of unrecognized investment losses and actuarial
gains at December 31, 2002 is $418.9 million. This amount impacts the
actuarially determined prepaid pension amount recorded on the consolidated
balance sheet but has no impact on expected Plan funding.
The discount rate that is utilized in determining future pension obligations
is based on a basket of long-term bonds that receive one of the two highest
ratings given by a recognized rating agency. To compensate for the Plan’s
longer duration 0.25 percent was added to this rating. The discount rate
determined on this basis has decreased from 7.25 percent at December 31,
2001 to 6.75 percent at December 31, 2002.
Due to the effect of the unrecognized actuarial losses and based on an
expected rate of return on Plan assets of 8.75 percent, a discount rate of
6.75 percent and various other assumptions, NU estimates that pension
income/expense for the Plan will be approximately $31 million in income,
approximately $7 million in expense and approximately $39 million in
expense in 2003, 2004 and 2005, respectively. Future actual pension
income/expense will depend on future investment performance, changes
in future discount rates and various other factors related to the populations
participating in the plan.