Pepsi 2009 Annual Report Download - page 60

48 PepsiCo, Inc. 2009 Annual Report
Management’s Discussion and Analysis
PENSION AND RETIREE MEDICAL PLANS
Our pension plans cover full-time employees 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. and Canada retirees are also eligible for medical
and life insurance benefits (retiree medical) if they meet age and
service requirements. Generally, our share of retiree medical costs
is capped at specified dollar amounts which 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 related 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 (interest 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 measure 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 manage-
ment’s best judgment regarding future expectations. Due to the
significant management judgment involved, our assumptions
could have a material impact on the measurement of our pension
and retiree medical benefit 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 in the U.S. and
adjusted for differences between the average duration of the bonds
in this Index and the average duration of our benefit liabilities, based
upon a published index. As of the beginning of our 2008 fiscal
year, our U.S. discount 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.
The Mercer Yield Curve includes bonds that closely match the timing
and amount of our expected benefit payments.
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 inflation to assess the reasonableness 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 benefit payments. Our
investment objective is to ensure that funds are available to meet
the plans’ benefit obligations when they become due. Our overall
investment strategy is to prudently invest plan assets in high-quality
and diversified equity and debt securities to achieve our long-term
return expectations. 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%,
reflecting estimated long-term rates of return of 8.9% from our
equity allocations and 6.3% from our fixed income allocations.
Our target investment allocation is 40% for U.S. equity allocations,
20% for international equity allocations and 40% for fixed income
allocations. 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
allocations over a five-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 differing
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 benefit of
88045_pepsico-09ar_33-59_R1.indd 48 2/24/10 4:48 PM