Dominion Power 2004 Annual Report Download - page 31

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would be based on relevant information available at the time the estimates
are made, estimates of future cash flows are, by nature, highly uncertain
and may vary significantly from actual results. For example, estimates of
future cash flows would contemplate factors such as the expected use of
the asset, including future production and sales levels, and expected fluc-
tuations of prices of commodities sold and consumed.
During 2004, Dominion did not test any significant long-lived assets or
asset groups for impairment as no circumstances arose that indicated an
impairment may exist. In 2003, reflecting a significant revision in long-term
expectations for potential growth in telecommunications service revenue,
Dominion approved a strategy to sell its interest in the telecommunications
business. In connection with this change in strategy, Dominion tested the
network assets to be sold for impairment, using the revised long-term
expectations for potential growth. Dominion’s assets were determined to
be substantially impaired and were written down to fair value. Dominion
sold its telecommunications business in 2004.
Asset retirement obligations
Dominion recognizes liabilities for the expected cost of retiring tangible
long-lived assets for which a legal obligation exists. These asset retire-
ment obligations (AROs) are recognized at fair value as incurred, and are
capitalized as part of the cost of the related tangible long-lived assets. In
the absence of quoted market prices, Dominion estimates the fair value of
its AROs using present value techniques, in which Dominion makes various
assumptions including estimates of the amounts and timing of future cash
flows associated with retirement activities, credit-adjusted risk free rates
and cost escalation rates. AROs currently reported on Dominion’s Consoli-
dated Balance Sheets were measured during a period of historically low
interest rates. The impact on measurements of new AROs, using different
rates in the future, may be significant. Dominion did not recognize any new,
significant AROs in 2004. In the future, if Dominion revises any assump-
tions used to calculate the fair value of existing AROs, Dominion will adjust
the carrying amount of both the ARO liability and related long-lived asset.
Dominion records accretion expense, increasing the ARO liability, with the
passage of time. In 2004 and 2003, Dominion recognized $91 million and
$86 million, respectively, of accretion expense, and expects to incur
$95 million in 2005.
A significant portion of Dominion’s AROs relate to the future decommis-
sioning of its nuclear facilities. At December 31, 2004, nuclear decommis-
sioning AROs, which are reported in the Dominion Generation segment,
totaled $1.4 billion, representing approximately 82% of Dominion’s total
AROs. Based on their significance, the following discussion of critical
assumptions inherent in determining the fair value of AROs relates to those
associated with Dominion’s nuclear decommissioning obligations.
Dominion obtains from third-party experts periodic site-specific “base
year” cost studies in order to estimate the nature, cost and timing of
planned decommissioning activities for its utility nuclear plants. Dominion
uses internal cost studies for its merchant nuclear facility based on similar
methods. These cost studies are based on relevant information available at
the time they are performed; however, estimates of future cash flows for
extended periods are by nature highly uncertain and may vary significantly
from actual results. In addition, these cost estimates are dependent on
subjective factors, including the selection of cost escalation rates, which
Dominion considers to be a critical assumption.
Dominion determines cost escalation rates, which represent projected
cost increases over time, due to both general inflation and increases in the
cost of specific decommissioning activities, for each of its nuclear facili-
ties. The weighted average cost escalation used by Dominion was 3.18%.
The use of alternative rates would have been material to the liabilities rec-
ognized. For example, had Dominion increased the cost escalation rate by
0.5% to 3.68%, the amount recognized as of December 31, 2004 for its AROs
related to nuclear decommissioning would have been $269 million higher.
Employee benefit plans
Dominion sponsors noncontributory defined benefit pension plans and
other postretirement benefit plans for eligible active employees, retirees
and qualifying dependents. The costs of providing benefits under these
plans are dependent, in part, on historical information such as employee
demographics, the level of contributions made to the plans and earnings on
plan assets. Assumptions about the future, including the expected rate of
return on plan assets, discount rates applied to benefit obligations and the
anticipated rate of increase in health care costs and participant compensa-
tion, also have a significant impact on employee benefit costs. The impact
on pension and other postretirement benefit plan obligations associated
with changes in these factors is generally recognized in the Consolidated
Statements of Income over the remaining average service period of plan
participants rather than immediately.
The selection of expected long-term rates of return on plan assets,
discount rates and medical cost trend rates are critical assumptions.
Dominion determines the expected long-term rates of return on plan
assets for pension plans and other postretirement benefit plans by using
a combination of:
•Historical return analysis to determine expected future risk premiums;
•Forward-looking return expectations derived from the yield on long-
term bonds and the price earnings ratios of major stock market indices;
•Expected inflation and risk-free interest rate assumptions; and
•Investment allocation of plan assets. Dominion’s strategic target asset
allocation for its pension fund is 45% U.S. equity securities, 8% non-
U.S. equity securities, 22% debt securities and 25% other, such as real
estate and private equity investments.
Assisted by an independent actuary, management develops assump-
tions, which are then compared to the forecasts of other independent
investment advisors to ensure reasonableness. An internal committee
selects the final assumptions. Dominion calculated its pension cost using
an expected return on plan assets assumption of 8.75% for 2004 and 2003,
compared to 9.5% for 2002. Dominion calculated its 2004 other postretire-
ment benefit cost using an expected return on plan assets assumption of
7.79%, compared to 7.78% and 7.82% for 2003 and 2002, respectively. The
rate used in calculating other postretirement benefit cost is lower than
the rate used in calculating pension cost because of differences in the rela-
tive amounts of various types of investments held as plan assets and
because other postretirement benefit activity, unlike the pension activity, is
partially taxable.