Pepsi 2005 Annual Report Download - page 40

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Our pension plans cover full-time employ-
ees in the U.S. and certain international
employees. Benefits are determined based
on either years of service or a combination
of years of service and earnings. U.S. retirees
are also eligible for medical and life insur-
ance benefits (retiree medical) if they meet
age and service requirements. Generally,
our share of retiree medical costs is capped
at specified dollar amounts that vary
based upon years of service, with retirees
contributing the remainder of the cost.
Our Assumptions
The determination of pension and retiree
medical plan obligations and associated
expenses requires the use of assumptions
to estimate the amount of the benefits that
employees earn while working, as well as
the present value of those benefits. Annual
pension and retiree medical expense
amounts are principally based on four
components: (1) the value of benefits
earned by employees for working during
the year (service cost), (2) increase in the
liability due to the passage of time (inter-
est cost), and (3) other gains and losses as
discussed below, reduced by (4) expected
return on plan assets for our funded plans.
Significant assumptions used to meas-
ure our annual pension and retiree medical
expense include:
• the interest rate used to determine the
present value of liabilities (discount rate);
• certain employee-related factors, such as
turnover, retirement age and mortality;
• for pension expense, the expected return
on assets in our funded plans and the
rate of salary increases for plans where
benefits are based on earnings; and
• for retiree medical expense, health care
cost trend rates.
Our assumptions reflect our historical
experience and management’s best judg-
ment regarding future expectations. Some
of these assumptions require significant
management judgment and could have a
material impact on the measurement of
our pension and retiree medical benefit
expenses and obligations. The assumptions
used to measure our annual pension and
retiree medical expenses are determined as
of September 30 (measurement date) and
all plan assets and liabilities are generally
reported as of that date.
At each measurement date, the dis-
count rate is based on interest rates for
high-quality, long-term corporate debt
securities with maturities comparable to
our liabilities. In the U.S., we utilize the
Moody’s AA Corporate Index yield and
adjust for the differences between the aver-
age duration of the bonds in this Index and
the average duration of our benefits liabili-
ties based upon a published index.
The expected return on pension plan
assets is based on our historical experi-
ence, our pension plan investment strategy
and our expectations for long-term rates of
return. Our pension plan investment strat-
egy is reviewed annually and is based upon
plan liabilities, an evaluation of market
conditions, tolerance for risk, and cash
requirements for benefit payments. We use
a third-party advisor to assist us in deter-
mining our investment allocation and mod-
eling our long-term rate of return
assumptions. Our current investment allo-
cation target for our U.S. plans is 60% in
equity securities, with the balance in fixed
income securities and cash. Our expected
long-term rate of return assumptions on
U.S. plan assets is 7.8%, reflecting an
estimated long-term return of 9.3% from
equity securities and an estimated 5.8%
from fixed income securities. Approximately
80% of our pension plan assets relate to
our U.S. plans. We use a market-related
value method that recognizes each year’s
asset gain or loss over a five-year period.
Therefore, it takes five years for the gain or
loss from any one year to be fully included
in the other gains and losses calculation
described below.
Other gains and losses resulting from
actual experience differing from our
assumptions and from changes in our
assumptions are also determined at each
measurement date. If this net accumulated
gain or loss exceeds 10% of the greater of
plan assets or liabilities, a portion of the
net gain or loss is included in expense for
the following year. The cost or benefit of
plan changes which increase or decrease
benefits for prior employee service (prior
service cost) is included in expense on a
straight-line basis over the average remain-
ing service period of those expected to
benefit, which is approximately 11 years
for pension expense and approximately
13 years for retiree medical.
Pension and Retiree Medical Plans
The discount rate is based on
interest rates for high-quality,
long-term corporate debt
securities with maturities
comparable to our liabilities.
Weighted-average assumptions for pension and retiree medical expense are the following:
2006 2005 2004
Pension
Expense discount rate 5.6% 6.1% 6.1%
Expected rate of return on plan assets 7.7% 7.8% 7.8%
Expected rate of compensation increases 4.4% 4.3% 4.4%
Retiree medical
Expense discount rate 5.7% 6.1% 6.1%
Current health care cost trend rate 10.0% 11.0% 12.0%