Pepsi 2008 Annual Report Download - page 56

54 PepsiCo, Inc. 2008 Annual Report
Management’s Discussion and Analysis
Signicant assumptions used to measure our annual pension
and retiree medical expense include:
• the interest rate used to determine the present value of liabili-
ties (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
benets are based on earnings; and
• for retiree medical expense, health care cost trend rates.
Our assumptions reect our experience and management’s
best judgment regarding future expectations. Due to the signi-
cant management judgment involved, our assumptions could
have a material impact on the measurement of our pension and
retiree medical benet expenses and obligations.
At each measurement date, the discount rate is based on
interest rates for high-quality, long-term corporate debt securities
with maturities comparable to those of our liabilities. Prior to
2008, we used the Moody’s Aa Corporate Bond Index yield
(Moody’s Aa Index) in the U.S. and adjusted for differences
between the average duration of the bonds in this Index and the
average duration of our benet liabilities, based upon a published
index. As of the beginning of our 2008 scal year, our U.S. dis-
count rate is determined using the Mercer Pension Discount
Yield Curve (Mercer Yield Curve). The Mercer Yield Curve uses
a portfolio of high-quality bonds rated Aa or higher by Moody’s.
We believe the Mercer Yield Curve includes bonds that provide a
better match to the timing and amount of our expected benet
payments than the Moody’s Aa Index.
The expected return on pension plan assets is based on our
pension plan investment strategy, our expectations for long-term
rates of return and our historical experience. We also review
current levels of interest rates and ination to assess the reason-
ableness of the long-term rates. Our pension plan investment
strategy includes the use of actively-managed securities and is
reviewed annually based upon plan liabilities, an evaluation of
market conditions, tolerance for risk and cash requirements for
benet payments. Our investment objective is to ensure that
funds are available to meet the plans’ benet obligations when
they become due. Our overall investment strategy is to prudently
invest plan assets in high-quality and diversied equity and debt
securities to achieve our long-term return expectations. We
employ certain equity strategies which, in addition to investments
in U.S. and international common and preferred stock, include
investments in certain equity- and debt-based securities used
collectively to generate returns in excess of certain equity-based
indices. Debt-based securities represent approximately 3% and
30% of our equity strategy portfolio as of year-end 2008 and
2007, respectively. Our investment policy also permits the use
of derivative instruments which are primarily used to reduce risk.
Our expected long-term rate of return on U.S. plan assets is 7.8%,
reecting estimated long-term rates of return of 8.9% from our
equity strategies, and 6.3% from our xed income strategies.
Our target investment allocation is 60% for equity strategies and
40% for xed income strategies. Actual investment allocations
may vary from our target investment allocations due to prevailing
market conditions. We regularly review our actual investment
allocations and periodically rebalance our investments to our
target allocations. To calculate the expected return on pension
plan assets, we use a market-related valuation method that
recognizes investment gains or losses (the difference between
the expected and actual return based on the market-related
value of assets) for securities included in our equity strategies
over a ve-year period. This has the effect of reducing year-to-
year volatility. For all other asset categories, the actual fair value
is used for the market-related value of assets.
The difference between the actual return on plan assets and
the expected return on plan assets is added to, or subtracted
from, other gains and losses resulting from actual experience dif-
fering from our assumptions and from changes in our assumptions
determined at each measurement date. If this net accumulated
gain or loss exceeds 10% of the greater of the market-related
value of plan assets or plan liabilities, a portion of the net gain
or loss is included in expense for the following year. The cost or
benet of plan changes that increase or decrease benets for
prior employee service (prior service cost/(credit)) is included
in earnings on a straight-line basis over the average remaining
service period of active plan participants, which is approximately
10 years for pension expense and approximately 12 years for
retiree medical expense.