Alcoa 2010 Annual Report Download - page 78

The expected long-term rate of return on plan assets is generally applied to a five-year market-related value of plan
assets (a four-year average or the fair value at the plan measurement date is used for certain non-U.S. plans). The
process used by management to develop this assumption has expanded from one that relied primarily on historical asset
return information to one that also incorporates forward-looking returns by asset class, as described below.
Prior to developing the expected long-term rate of return for calendar year 2009, management focused on historical
actual returns (annual, 10-year moving, and 20-year moving averages) when developing this assumption. Based on that
process, management utilized 9% for the expected long-term rate of return for several years through 2008. For calendar
year 2009, the expected long-term rate of return was reduced to 8.75% due to lower future expected market returns as a
result of the then global economic downturn. This was supported by the fact that, in 2008, the 10-year moving average
of actual performance fell below 9% for the first time in 20 years, although the 20-year moving average continued to
exceed 9%.
For calendar year 2010, management expanded its process by incorporating expected future returns on current and
planned asset allocations using information from various external investment managers and management’s own
judgment. Management considered this forward-looking analysis as well as the historical return information, and
concluded the expected rate of return for calendar 2010 would remain at 8.75%, which was between the 20-year
moving average actual return performance and the estimated future return developed by asset class.
For calendar year 2011, management again incorporated both actual historical return information and expected future
returns into its analysis. Based on strategic asset allocations and current estimates of future returns by asset class,
management will be using 8.50% as its expected long-term rate of return for 2011. This rate again falls within the
range of the 20-year moving average of actual performance and the expected future return developed by asset class.
A change in the assumption for the expected long-term rate of return on plan assets of 1/4 of 1% would impact after-tax
earnings by approximately $16 for 2011.
In 2010, a net charge of $216 ($138 after-tax) was recorded in other comprehensive income, primarily due to a 40 basis
point decrease in the discount rate, which was somewhat offset by the favorable performance of the plan assets and the
recognition of actuarial losses and prior service costs. In 2009, a net charge of $182 ($102 after-tax) was recorded in
other comprehensive loss, primarily due to a 25 basis point decrease in the discount rate, which was somewhat offset
by the favorable performance of the plan assets and the recognition of actuarial losses and prior service costs.
Additionally, in 2010 and 2009, a charge of $2 and $8, respectively, was recorded in accumulated other comprehensive
loss due to the reclassification of deferred taxes related to the Medicare Part D prescription drug subsidy.
Stock-based Compensation. Alcoa recognizes compensation expense for employee equity grants using the
non-substantive vesting period approach, in which the expense (net of estimated forfeitures) is recognized ratably over
the requisite service period based on the grant date fair value. The fair value of new stock options is estimated on the
date of grant using a lattice-pricing model. Determining the fair value of stock options at the grant date requires
judgment, including estimates for the average risk-free interest rate, dividend yield, volatility, annual forfeiture rate,
and exercise behavior. These assumptions may differ significantly between grant dates because of changes in the actual
results of these inputs that occur over time.
As part of Alcoa’s stock-based compensation plan design, individuals who are retirement-eligible have a six-month
requisite service period in the year of grant. Equity grants are issued in January each year. As a result, a larger portion
of expense will be recognized in the first half of each year for these retirement-eligible employees. Compensation
expense recorded in 2010, 2009, and 2008 was $84 ($57 after-tax), $87 ($58 after-tax), and $94 ($63 after-tax),
respectively. Of this amount, $19, $21, and $19 in 2010, 2009, and 2008, respectively, pertains to the acceleration of
expense related to retirement-eligible employees.
Plan participants can choose whether to receive their award in the form of stock options, stock awards, or a
combination of both. This choice is made before the grant is issued and is irrevocable.
70