Progress Energy 2007 Annual Report Download - page 36

MANAGEMENT’S DISCUSSION AND ANALYSIS
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See further discussion in “Other Matters – Synthetic
Fuels Tax Credits.”
Pension Costs
As discussed in Note 16A, we maintain qualified
noncontributory defined benefit retirement (pension)
plans. Our reported costs are dependent on numerous
factors resulting from actual plan experience and
assumptions of future experience. For example, such
costs are impacted by employee demographics, changes
made to plan provisions, actual plan asset returns and
key actuarial assumptions, such as expected long-term
rates of return on plan assets and discount rates used in
determining benefit obligations and annual costs.
Due to an increase in the market interest rates for
high-quality (AAA/AA) debt securities, which are used
as the benchmark for setting the discount rate used to
present value future benefit payments, we increased the
discount rate to approximately 6.20% at December 31,
2007, from approximately 5.95% at December 31, 2006,
which will decrease the 2008 benefit costs recognized,
all other factors remaining constant. Our discount rates
are selected based on a plan-by-plan study, which
matches our projected benefit payments to a high-quality
corporate yield curve. Plan assets performed well in 2007,
with returns of approximately 13%. That positive asset
performance will result in decreased pension costs in
2008, all other factors remaining constant. In addition,
contributions to pension plan assets in 2007 and 2008 will
result in decreased pension costs in 2008 due to increased
asset returns, all other factors remaining constant.
Evaluations of the effects of these and other factors on
our 2008 pension costs have not been completed, but
we estimate that the total cost recognized for pensions
in 2008 will be $10 million to $20 million, compared with
$31 million recognized in 2007.
We have pension plan assets with a fair value of
approximately $2.0 billion at December 31, 2007. Our
expected rate of return on pension plan assets is 9.0%.
We review this rate on a regular basis. Under SFAS
No. 87, “Employer’s Accounting for Pensions” (SFAS
No. 87), the expected rate of return used in pension cost
recognition is a long-term rate of return; therefore, we
do not adjust that rate of return frequently. In 2005, we
elected to lower our expected rate of return from 9.25%
to 9.0%. The 9.0% rate of return represents the lower
end of our future expected return range given our asset
allocation policy. A 0.25% change in the expected rate of
return for 2007 would have changed 2007 pension costs
by approximately $4 million.
Another factor affecting our pension costs, and sensitivity
of the costs to plan asset performance, is the method
selected to determine the market-related value of assets,
i.e., the asset value to which the 9.0% expected long-
term rate of return is applied. SFAS No. 87 specifies that
entities may use either fair value or an averaging method
that recognizes changes in fair value over a period not to
exceed five years, with the method selected applied on a
consistent basis from year to year. We have historically
used a five-year averaging method. When we acquired
Florida Progress in 2000, we retained the Florida Progress
historical use of fair value to determine market-related
value for Florida Progress pension assets. Changes in plan
asset performance are reflected in pension costs sooner
under the fair value method than the five-year averaging
method, and, therefore, pension costs tend to be more
volatile using the fair value method. Approximately
50 percent of our pension plan assets are subject to each
of the two methods.
LIQUIDITY AND CAPITAL RESOURCES
Overview
Progress Energy, Inc. is a holding company and, as such,
has no revenue-generating operations of its own. Our
primary cash needs at the Parent level are our common
stock dividend and interest and principal payments on
our $2.6 billion of senior unsecured debt. Our ability to
meet these needs is dependent on the earnings and
cash flows of the Utilities, and the ability of the Utilities
to pay dividends or repay funds to us. As discussed under
“Future Liquidity and Capital Resources” below, synthetic
fuels tax credits provide an additional source of liquidity
as those credits are realized. Our other significant cash
requirements arise primarily from the capital-intensive
nature of the Utilities’ operations, including expenditures
for environmental compliance. We rely upon our
operating cash flow, primarily generated by the Utilities,
commercial paper and bank facilities, and our ability to
access the long-term debt and equity capital markets for
sources of liquidity.
The majority of our operating costs are related to
the Utilities. Most of these costs are recovered from
ratepayers in accordance with various rate plans. We
are allowed to recover certain fuel, purchased power
and other costs incurred by PEC and PEF through
their respective recovery clauses. The types of costs
recovered through clauses vary by jurisdiction. Fuel price
volatility can lead to over- or under-recovery of fuel costs,
as changes in fuel prices are not immediately reflected
in fuel surcharges due to regulatory lag in setting the