Dominion Power 2006 Annual Report Download - page 35

MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
accrete the ARO liability to reflect the passage of time. In 2006,
2005 and 2004, we recognized $109 million, $102 million and
$91 million, respectively, of accretion, andexpect toincur $82
million in 2007.
Asignificant portion of our AROs relates to the future decom-
missioning of our nuclear facilities. At December 31, 2006,
nuclear decommissioning AROs, which are reported in the
Dominion Generation segment, totaled $1.4 billion, representing
approximately 73% of our total AROs. Based on their sig-
nificance, the following discussion of critical assumptions
inherent in determiningthe fair value of AROs relates to those
associated with our nuclear decommissioning obligations.
We obtain from third-party specialists periodic site-specific
base year cost studies in order to estimate the nature,cost and
timingofplanned decommissioning activities forour utility and
merchant nuclear plants. We obtained updated cost studies forall
of our nuclear plants in 2006 which generally reflected increases
in base year costs. These cost studies are based on relevant
information available at the time they are performed;however,
estimates of future cash flows for extended periods of time are by
nature highly uncertain and mayvary significantly from actual
results. In addition, our cost estimates include cost escalation rates
that are appliedto the base year costs.Theselectionof these cost
escalation rates is dependent on subjective factors which we con-
sider to be a critical assumption.
We determine 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 our nuclear facilities. In 2006, we lowered the cost escala-
tion rate assumptionsused in the ARO calculation by 0.72% due
to projected reductions in both general and decommissioning
specific inflation rates, resulting in a $481 million decrease in our
nuclear decommissioning AROs.
EMPLOYEE BENEFIT PLANS
We sponsor noncontributory defined benefit pensionplans and
other postretirement benefit plans foreligible active employees,
retirees and qualifying dependents. The projected costs of provid-
ing benefits under these plans are dependent, in part, on historical
information such as employee demographics, the level of con-
tributions made to the plans and earnings on plan assets. Assump-
tionsabout the future,including the expected rate of return on
plan assets, discountrates applied to benefit obligationsand the
anticipated rate of increase in health care costs and participant
compensation, also have a significant impact on employee benefit
costs. The impact on pensionand other postretirement benefit
plan obligationsassociated with changes in these factors is gen-
erally recognized in our Consolidated Statements of Income over
the remainingaverageservice period of plan participants rather
than immediately.
The expected long-term rates of return on plan assets, discount
rates and medicalcost trend rates are critical assumptions. We
determine the expected long-term rates of return on plan assets
forpension plans and other postretirement benefit plans by using
acombination of:
Historicalreturn 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. Effective September 1,
2006, the strategic target asset allocation for our pensionfund
is 34% U.S. equity securities, 12% non-U.S. equity securities,
22% debt securities, 7% real estate and 25% other, such as
private equity investments. Prior to September 1, 2006, the
strategic target asset allocation for our pensionfund was 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, we develop assumptions,
which are thencompared to the forecasts of other independent
investment advisors to ensure reasonableness. An internal
committee selects the final assumptions. We calculated our pen-
sion cost using an expected return on plan assetsassumption of
8.75% for 2006, 2005 and 2004. We calculatedour2006 and
2005 other postretirement benefit cost using an expected return
on plan assetsassumption of 8.00% compared to 7.79% for
2004. The rate usedin calculating other postretirement benefit
cost is lower than the rate used in calculating pensioncost because
of differences in the relative amounts of various types of invest-
ments held as plan assets.
We determine discountrates from analyses performed by a
third-party actuarial firm of AA/Aa rated bondswith cash flows
matchingthe expected payments to be made underourplans.
The discount rates used to calculate 2006 pensioncost and other
postretirementbenefit cost were 5.60% and 5.50%, respectively,
compared to the 6.00% and 6.25% discountrates used to calcu-
late 2005 and 2004 pensionand other postretirement benefit
costs, respectively. Lower long-termbond yieldswere the primary
reasonfor the decline in the discount rate from 2005 to 2006.
We selected discount rates of 6.20% and 6.10% fordetermining
our December 31, 2006 projected pensionand postretirement
benefit obligations, respectively.
We establish themedical cost trend rate assumption based on
analyses performed by athird-party actuarial firm of various fac-
tors including the specific provisions of our medicalplans,actual
cost trendsexperiencedand projected,anddemographics of plan
participants. Our medicalcost trend rate assumption as of
December 31, 2006 is 9.00% and is expected to gradually
decrease to 5.00% in later years.
The following table illustratestheeffect on cost of changing
the critical actuarial assumptions previouslydiscussed, while hold-
ing all other assumptions constant:
Increase in
Net Periodic Cost
Actuarial Assumption
Change in
Assumption
Pension
Benefits
Other
Postretirement
Benefits
(millions, except percentages)
Discount rate(0.25)% $13 $3
Rate of return on plan assets (0.25)% 11 2
Healthcare cost trend rate 1% N/A 30
In addition to the effects on cost, a 0.25% decrease in the
discountratewould increase our projected pension benefit obliga-
tion by $122 million andwould increase our accumulated post-
retirement benefit obligation by $38 million at December 31,
2006.
34 DOMINION2006 Annual Report