Eversource 2003 Annual Report Download - page 40

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Discount Rate: The discount rate that is utilized in determining future
pension and PBOP obligations is based on a basket of long-term bonds
that receive one of the two highest ratings given by a recognized rating
agency. To compensate for the Pension Plan’s longer duration, 25 basis
points were added to the benchmark. The discount rate determined on
this basis has decreased from 6.75 percent at December 31, 2002 to
6.25 percent at December 31, 2003.
Expected Pension Expense: Due to the effect of the unrecognized actuarial
losses and based on an expected rate of return on Pension Plan assets of
8.75 percent, a discount rate of 6.25 percent and various other
assumptions, NU estimates that expected contributions to and pension
expense for the Pension Plan will be as follows (in millions):
Expected Pension
Year Contributions Expense
2004 $ — $ 2.9
2005 $ — $21.2
2006 $ — $26.6
Future actual pension income/expense will depend on future investment
performance, changes in future discount rates and various other factors
related to the populations participating in the Pension Plan.
Sensitivity Analysis: The following represents the increase/(decrease) to
the Pension Plan’s reported cost and to the PBOP Plan’s reported cost as
a result of the change in the following assumptions by 50 basis points
(in millions):
At December 31,
Pension Plan Postretirement Plan
Assumption Change 2003 2002 2003 2002
Lower long-term rate of return $10.7 $10.7 $0.9 $1.1
Lower discount rate $12.3 $11.0 $1.0 $1.1
Lower compensation increase $ (5.9) $ (5.0) N/A N/A
Plan Assets: The value of the Pension Plan assets has increased from $1.6
billion at December 31, 2002 to $1.9 billion at December 31, 2003. The
investment performance returns, despite declining discount rates, have
increased the funded status of the Pension Plan on a projected benefit
obligation (PBO) basis from an underfunded position of $157.5 million at
December 31, 2002 to an overfunded position of $3.8 million at
December 31, 2003. The PBO includes expectations of future employee
compensation increases. The accumulated benefit obligation (ABO) of
the Pension Plan was approximately $240 million less than Pension Plan
assets at December 31, 2003 and approximately $78 million less than
Pension Plan assets at December 31, 2002. The ABO is the obligation for
employee service and compensation provided through December 31,
2003. If the ABO exceeds Pension Plan assets at a future plan measure-
ment date, NU will record an additional minimum liability. NU has not
made employer contributions since 1991.
The value of PBOP Plan assets has increased from $147.7 million at
December 31, 2002 to $178 million at December 31, 2003. The investment
performance returns, despite declining discount rates, have decreased
the underfunded status of the PBOP Plan on an accumulated projected
benefit obligation basis from $250.1 million at December 31, 2002 to
$227 million at December 31, 2003. NU has made a contribution each
year equal to the PBOP Plan’s postretirement benefit cost, excluding
curtailments, settlements and special termination benefits.
Health Care Cost: The health care cost trend assumption used to project
increases in medical costs is 9 percent for 2003, decreasing one percentage
point per year to an ultimate rate of 5 percent in 2007. The effect of
increasing the health care cost trend by one percentage point would
have increased 2003 service and interest cost components of the PBOP
Plan cost by $0.8 million in 2003 and $0.9 million in 2002.
Accounting for the Effect of Medicare Changes on PBOP: On December 8,
2003, the President signed into law a bill that expands Medicare,
primarily by adding a prescription drug benefit and by adding a federal
subsidy to qualifying plan sponsors of retiree health care benefit plans.
Management believes that NU currently qualifies.
Specific authoritative accounting guidance on how to account for the
effect the Medicare federal subsidy has on NU’s PBOP Plan has not been
issued by the FASB. FASB Staff Position (FSP) No. FAS 106-1, “Accounting
and Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003,” required NU to make an
election for 2003 financial reporting. The election was to either defer the
impact of the subsidy until the FASB issues guidance or to reflect the
impact of the subsidy on December 31, 2003 reported amounts. NU
chose to reflect the impact on December 31, 2003 reported amounts.
Reflecting the impact of the Medicare change decreased the PBOP benefit
obligation by $19.5 million and increased actuarial gains by $19.5 million
with no impact on 2003 expenses, assets, or liabilities. The $19.5 million
actuarial gain will be amortized as a reduction to PBOP expense over 13
years beginning in 2004. PBOP expense in 2004 will also reflect a lower
interest cost due to the reduction in the December 31, 2003 benefit
obligation. Management estimates that the reduction in PBOP expense
in 2004 will be approximately $2 million.
When accounting guidance is issued by the FASB, it may require NU to
change the accounting described above and change the information
included in this annual report.
Income Taxes: Income tax expense is calculated each year in each of the
jurisdictions in which NU operates. This process involves estimating NU’s
actual current tax exposures as well as assessing temporary differences
resulting from differing treatment of items, such as timing of the deduction
and expenses for tax and book accounting purposes. These differences
result in deferred tax assets and liabilities, which are included in NU’s
consolidated balance sheets. The income tax estimation process impacts
all of NU’s segments. Adjustments made to income taxes could signifi-
cantly affect NU’s consolidated financial statements. Management must
also assess the likelihood that deferred tax assets will be recovered from
future taxable income, and to the extent that recovery is not likely, a
valuation allowance must be established. Significant management
judgment is required in determining income tax expense, deferred tax
assets and liabilities and valuation allowances.
NU accounts for deferred taxes under SFAS No. 109, “Accounting for
Income Taxes.” For temporary differences recorded as deferred tax liabilities
that will be recovered in rates in the future, NU has established a regulatory
asset. The regulatory asset amounted to $253.8 million and $326.4 million
at December 31, 2003 and 2002, respectively. Regulatory agencies in
certain jurisdictions in which NU’s Utility Group companies operate
require the tax effect of specific temporary differences to be “flowed
through” to utility customers. Flow through treatment means that
deferred tax expense is not recorded on the consolidated statements of