Pepsi 2013 Annual Report Download - page 63

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• the interest rate used to determine the present value of liabilities (discount rate);
• certain employee-related factors, such as turnover, retirement age and mortality;
• the expected return on assets in our funded plans;
• for pension expense, 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 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 rates are based on interest rates for high-quality, long-term corporate
debt securities with maturities comparable to those of our liabilities. In 2011, our U.S. discount rate was
determined using the Mercer Pension Discount Yield Curve (Mercer Curve). The Mercer Curve used a
portfolio of high-quality bonds rated Aa or higher by Moody’s. In 2012, due to the downgrade of several
global financial institutions by Moody’s, Mercer developed a new curve, the Above Mean Curve, which we
used to determine the discount rate for our U.S. pension and retiree medical plans as of year-end 2012 and
going forward. These curves include bonds that closely match the timing and amount of our expected benefit
payments and reflect the portfolio of investments we would consider to settle our liabilities.
The expected return on pension plan assets is based on our pension plan investment strategy and our
expectations for long-term rates of return by asset class, taking into account volatility and correlation among
asset classes and our historical experience. We also review current levels of interest rates and inflation to
assess the reasonableness of the long-term rates. We evaluate our expected return assumptions annually to
ensure that they are reasonable. Our pension plan investment strategy includes the use of actively managed
securities and is reviewed periodically in conjunction with 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 a well-diversified portfolio of equity and high-quality debt
securities and real estate 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 7.5% for 2014 and 7.8% for 2013.
Our target investment allocations are as follows:
2014 2013
Fixed income 40% 40%
U.S. equity 33% 33%
International equity 22% 22%
Real estate 5% 5%
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, our market-related value
of assets for fixed income is the actual fair value. For all other asset categories, we use a method that recognizes
investment gains or losses (the difference between the expected and actual return based on the market-related
value of assets) over a five-year period. This has the effect of reducing year-to-year volatility.
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