Federal Express 2006 Annual Report Download - page 56

FEDEX CORPORATION
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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
actuaries, 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. This bond
modeling technique allows for the use of certain callable bonds
that meet a screening criteria that implies a low probability of call.
We believe this low call probability results in a bond yield with
a market presumption that the bond will not be called. In our
February 28, 2006 measurement date actuarial valuation, we
further refined our screens and assumed the callable bonds
would be redeemed at the earliest call date with no call
premium. To the extent scheduled bond proceeds exceed the
estimated benefit payments in a given period, the yield calcula-
tion assumes those excess proceeds are reinvested at the
one-year forward rates implied by the Citigroup Pension
Discount Curve. The continuing trend of declines in the discount
rate negatively affected our primary domestic pension plan
expense by $20 million in 2004, $32 million in 2005 and $101 million
in 2006. Pension cost will be negatively affected in 2007 by
approximately $89 million due to the continuing decline in the
discount rate.
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, 2006, with approximately $10 billion of
plan assets, a one-basis-point change in this assumption for our
domestic pension plans affects pension cost by approximately
$1 million (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 principal
U.S. domestic pension plan assets since 2004 and anticipate
using the same assumption for 2007.
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); and
• 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 to assist us in our reviews.
These studies project our estimated 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 in
connection with the introduction of the Portable Pension Account
(discussed below), which will reduce our liability duration over
time. That study supported management’s estimate of our long-
term rate of return on plan assets of 9.10%. The results of this
study were reaffirmed for 2005 and 2006 by our third-party pro-
fessional investment advisors and actuaries and support our
current asset allocation strategy, which is summarized below:
Percent of Plan Assets at M easurement Date
2006 2005
Asset Class Actual Target Actual Target
Domestic equities 54% 53% 53% 53%
International equities 20 17 20 17
Private equities 3 5 2 5
Total equities 77 75 75 75
Long duration fixed
income securities 14 15 15 15
Other fixed income securities 910 10 10
100% 100% 100% 100%
The actual historical return on our pension plan assets, calculated
on a compound geometric basis, was 10.0%, net of investment
manager fees, for the 15-year period ended February 28, 2006. In
addition, our actual return on plan assets exceeded the estimated
return in each of the past three fiscal years.
Pension expense is also affected by the accounting policy used
to determine the value of plan assets at the measurement date.
We use a calculated-value method to determine the value of
plan assets, which helps mitigate short-term volatility in market
performance (both increases and decreases). Another method
used in practice applies the market value of plan assets at the
measurement date. The application of the calculated-value
method reduced 2004 pension cost by approximately $106
million. The application of the calculated-value method approxi-
mated the result from applying the market-value method for both
2006 and 2005.
Salary Increases. The assumed future increase in salaries
and wages is also a key estimate in determining pension cost.
Generally, we correlate changes in estimated future salary
increases to changes in the discount rate (since that is an
indicator of general inflation and cost of living adjustments) and
general estimated levels of profitability (since most incentive
compensation is a component of pensionable wages). Due to pay
structure trends and our improving financial performance, the
average future salary increases based on age, were adjusted