Entergy 2006 Annual Report Download - page 62

ENTERGY CORPORATION AND SUBSIDIARIES 2
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■FUTURE OPERATING COSTS – Entergy assumes relatively minor
annual increases in operating costs. Technological or regulatory
changes that have a significant impact on operations could cause
a significant change in these assumptions.
In the fourth quarter of 2005, Entergy recorded a charge of $39.8
million ($25.8 million net-of-tax) as a result of the impairment of the
Competitive Retail Services business’ information technology sys-
tems. Entergy decided to divest the retail electric portion of the
Competitive Retail Services business operating in the ERCOT region
of Texas and, in connection with that decision, management evaluat-
ed the carrying amount of the Competitive Retail Services business’
information technology systems and determined that an impairment
provision should be recorded.
In the fourth quarter of 2004, Entergy recorded a charge of approxi-
mately $55 million ($36 million net-of-tax) as a result of an impairment
of the value of the Warren Power plant. Entergy concluded that the value
of the plant, which is owned in the non-nuclear wholesale assets busi-
ness, was impaired. Entergy reached this conclusion based on valuation
studies prepared in connection with the Entergy Asset Management
stock sale discussed above in “Results of Operations.”
QUALIFIED PENSION AND OTHER POSTRETIREMENT BENEFITS
Entergy sponsors qualified, defined benefit pension plans which cover
substantially all employees. Additionally, Entergy currently provides
postretirement health care and life insurance benefits for substantially all
employees who reach retirement age while still working for Entergy.
Entergy’s reported costs of providing these benefits, as described in Note
11 to the consolidated financial statements, are impacted by numerous
factors including the provisions of the plans, changing employee demo-
graphics, and various actuarial calculations, assumptions, and accounting
mechanisms. Because of the complexity of these calculations, the long-
term nature of these obligations, and the importance of the assumptions
utilized, Entergy’s estimate of these costs is a critical accounting estimate
for the Utility and Non-Utility Nuclear segments.
Assumptions
Key actuarial assumptions utilized in determining these costs include:
■Discount rates used in determining the future benefit obligations;
■Projected health care cost trend rates;
■Expected long-term rate of return on plan assets; and
■Rate of increase in future compensation levels.
Entergy reviews these assumptions on an annual basis and adjusts
them as necessary. The falling interest rate environment and worse-
than-expected performance of the financial equity markets in previous
years have impacted Entergy’s funding and reported costs for these
benefits. In addition, these trends have caused Entergy to make a
number of adjustments to its assumptions.
In selecting an assumed discount rate to calculate benefit obliga-
tions, Entergy reviews market yields on high-quality corporate debt
and matches these rates with Entergy’s projected stream of benefit
payments. Based on recent market trends, Entergy increased its dis-
count rate used to calculate benefit obligations from 5.9% in 2005 to
6.00% in 2006. Entergy’s assumed discount rate used to calculate the
2004 benefit obligations was 6.00%. Entergy reviews actual recent
cost trends and projected future trends in establishing health care cost
trend rates. Based on this review, Entergy’s health care cost trend rate
assumption used in calculating the December 31, 2006 accumulated
postretirement benefit obligation was a 10% increase in health care
costs in 2007 gradually decreasing each successive year, until it reaches a
4.5% annual increase in health care costs in 2012 and beyond.
In determining its expected long-term rate of return on plan assets,
Entergy reviews past long-term performance, asset allocations, and
long-term inflation assumptions. Entergy targets an asset allocation
for its pension plan assets of roughly 65% equity securities, 31%
fixed-income securities and 4% other investments. The target alloca-
tion for Entergy’s other postretirement benefit assets is 51% equity
securities and 49% fixed-income securities. Entergy’s expected long-
term rate of return on plan assets used to calculate benefit obligations
was 8.5% in 2006, 2005 and 2004. The assumed rate of increase in
future compensation levels used to calculate benefit obligations was
3.25% in 2006, 2005 and 2004.
Cost Sensitivity
The following chart reflects the sensitivity of qualified pension cost to
changes in certain actuarial assumptions (dollars in thousands):
Impact on Impact on
Actuarial Change in 2006 Qualified Qualified Projected
Assumption Assumption Pension Cost Benefit Obligation
Increase/(Decrease)
Discount rate (0.25%) $11,746 $110,087
Rate of return
on plan assets (0.25%) $ 5,311 –
Rate of increase
in compensation 0.25% $ 6,034 $ 33,326
The following chart reflects the sensitivity of postretirement
benefit cost to changes in certain actuarial assumptions (dollars
in thousands):
Impact on
Impact on 2006 Accumulated
Actuarial Change in Postretirement Postretirement
Assumption Assumption Benefit Cost Benefit Obligation
Increase/(Decrease)
Health care
cost trend 0.25% $5,294 $25,774
Discount rate (0.25%) $3,510 $31,008
Each fluctuation above assumes that the other components of the
calculation are held constant.
Accounting Mechanisms
In September 2006, FASB issued SFAS 158, “Employer’s Accounting
for Defined Benefit Pension and Other Postretirement Plans, an
amendment of FASB Statements Nos. 87, 88, 106 and 132(R),” to be
effective December 31, 2006. SFAS 158 requires an employer to rec-
ognize in its balance sheet the funded status of its benefit plans. Refer
to Note 11 to the financial statements for a further discussion of SFAS
158 and Entergy’s funded status.
In accordance with SFAS No. 87, “Employers’ Accounting for
Pensions,” Entergy utilizes a number of accounting mechanisms that
reduce the volatility of reported pension costs. Differences between
actuarial assumptions and actual plan results are deferred and are
amortized into expense only when the accumulated differences exceed
10% of the greater of the projected benefit obligation or the market-
related value of plan assets. If necessary, the excess is amortized over
the average remaining service period of active employees.
Additionally, Entergy accounts for the effect of asset performance
on pension expense over a twenty-quarter phase-in period through a
“market-related” value of assets calculation. Since the market-related
value of assets recognizes investment gains or losses over a twenty-
quarter period, the future value of assets will be impacted as
previously deferred gains or losses are recognized.
Entergy’s qualified pension accumulated benefit obligation at
December 31, 2005 exceeded plan assets. As a result, Entergy was
required to recognize an additional minimum pension liability as
prescribed by SFAS 87. At December 31, 2005, Entergy’s qualified
pension plans’ additional minimum pension liability was $406 million
($382 million net of related pension assets). Other comprehensive
income was $15 million at December 31, 2005, after reductions for
the unrecognized prior service cost, amounts recoverable in rates, and
taxes. Net income for 2005 and 2004 was not affected. In accordance
with SFAS 158, the additional minimum pension liability has been
replaced in 2006 with the recording of the funded status of the defined
benefit and other postretirement benefit plans.
MANAGEMENT’S FINANCIAL DISCUSSION and ANALYSIS continued