Federal Express 2005 Annual Report Download - page 53

MANAGEMENT’S DISCUSSION AND ANALYSIS
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and the payout of pension benefits will occur over an extended
period in the future. For example, only 6% of the participants cov-
ered under our principal pension plan are retired and currently
receiving benefits and the average remaining service life of our
employees approximates 14 years (normal retirement is at age
60). Total pension cost increased approximately $18 million in 2005
and approximately $115 million in 2004 primarily due to changes to
these estimates. Pension cost in 2006 for our U.S. domestic plans
is expected to increase $63 million. Pension cost is included in
the salaries and employee benefits caption in our consolidated
income statements.
Following are the components of pension cost recognized in our
income statements (in millions): 2005 2004 2003
Service cost $ 417 $ 376 $ 374
Interest cost 579 490 438
Expected return on plan assets (707) (597) (594)
Recognized actuarial losses 60 62 –
Other amortization 12 12 10
$ 361 $ 343 $ 228
Following is a discussion of the estimates we consider most
critical to determining our pension costs:
Discount Rate. This is the interest rate used to discount the esti-
mated future benefit payments that have been earned to date (the
projected benefit obligation and the accumulated benefit obliga-
tion) to their net present value. The discount rate is determined
each year at the plan measurement date (end of February) and
affects the succeeding year’s pension cost. A decrease in the
discount rate has a negative effect on pension expense.
This assumption is highly sensitive, as the following table
illustrates: Discount Sensitivity (in millions)(2)
Rate(1) Expense ABO
2006 n/a $2.1 n/a
2005 6.285% 1.8 $14
2004 6.78% 1.7 11
2003 6.99% 1.0 10
(1) The discount rate in effect at the end of the fiscal years affects the current year’s
accumulated benefit obligation (ABO) and the succeeding year’s pension expense.
(2) Sensitivities show the impact on expense and the ABO of a one-basis-point change in
the discount rate.
We determine the discount rate (which is required to be the rate
at which the projected benefit obligation could be effectively
settled as of the measurement date) with the assistance of actu-
aries, who calculate the yield on a theoretical portfolio of
high-grade corporate bonds (rated Aa or better) with cash flows
that generally match our expected benefit payments. To the extent
scheduled bond proceeds exceed the estimated benefit payments
in a given period, the yield calculation assumes those excess
proceeds are reinvested at the one-year forward rates implied by
the Citigroup Pension Discount Curve. This methodology is con-
sistently applied and involves little subjectivity. However, the
calculated discount rate can change materially from year to year
based on economic market conditions that impact yields on
corporate bonds available in the marketplace.
Plan Assets. Pension plan assets are invested primarily in listed
securities. Our pension plans hold only a minimal investment in
FedEx common stock that is entirely at the discretion of third-
party pension fund investment managers. The estimated average
rate of return on plan assets is a long-term, forward-looking
assumption that also materially affects our pension cost. It is
required to be the expected future long-term rate of earnings on
plan assets. At February 28, 2005, with approximately $8.7 billion
of plan assets, a one-basis-point change in this assumption for
our domestic pension plans affects pension cost by approxi-
mately $870,000 (a decrease in the assumed expected long-term
rate of return increases pension expense). We have assumed a
9.10% compound geometric long-term rate of return on our prin-
cipal U.S. domestic pension plan assets since 2004 and anticipate
using the same assumption for 2006.
Establishing the expected future rate of investment return on our
pension assets is a judgmental matter. Management considers
the following factors in determining this assumption:
• the duration of our pension plan liabilities, which drives the
investment strategy we can employ with our pension plan assets.
• the types of investment classes in which we invest our pension
plan assets and the expected compound geometric return we
can reasonably expect those investment classes to earn over
the next 10- to 15-year time period (or such other time period
that may be appropriate).
• the investment returns we can reasonably expect our active
investment management program to achieve in excess of the
returns we could expect if investments were made strictly in
indexed funds.
We review the expected long-term rate of return on an annual
basis and revise it as appropriate. Also, we periodically commis-
sion asset/liability studies performed by third-party professional
investment advisors and actuaries. These studies project our esti-
mated future pension payments and evaluate the efficiency of the
allocation of our pension plan assets into various investment
categories. These studies also generate probability-adjusted
expected future returns on those assets.
We last performed a detailed asset/liability study for 2004 based
on the introduction of the Portable Pension Account (discussed
below) which will reduce our liability duration over time, the sig-
nificant additional contributions we made into the plans and the