Progress Energy 2004 Annual Report Download - page 38

the Company’s regular federal income tax liability.
Synthetic fuels tax credit amounts allowed but not
utilized are carried forward indefinitely as deferred
alternative minimum tax credits on the Consolidated
Balance Sheets. All of Progress Energy’s synthetic fuel
facilities have received PLRs from the IRS with respect to
their operations, although these do not address placed-
in-service date determinations. The PLRs do not limit the
production on which synthetic fuel credits may be
claimed. The current Section 29 tax credit program
expires at the end of 2007. These tax credits are subject
to review by the IRS, and if Progress Energy fails to
prevail through the administrative or legal process, there
could be a significant tax liability owed for previously
taken Section 29 credits, with a significant impact on
earnings and cash flows. Additionally, the ability to use
tax credits currently being carried forward could be
denied. See further discussion in “OTHER MATTERS”
below, and Note 23E.
Pension Costs
As discussed in Note 17A, Progress Energy maintains
qualified noncontributory defined benefit retirement
(pension) plans. The Company’s reported costs are
dependent on numerous factors resulting from actual
plan experience and assumptions of future experience.
For example, such costs are impacted by employee
demographics, changes made to plan provisions, actual
plan asset returns and key actuarial assumptions, such
as expected long-term rates of return on plan assets and
discount rates used in determining benefit obligations
and annual costs.
Due to a slight decline in the market interest rates for
high-quality (AAA/AA) debt securities, which are used
as the benchmark for setting the discount rate used to
present value future benefit payments, the Company
lowered the discount rate to 5.9% at December 31, 2004,
which will increase the 2005 benefit costs recognized, all
other factors remaining constant. Plan assets performed
well in 2004, with returns of approximately 14%. That
positive asset performance will result in decreased
pension costs in 2005, all other factors remaining
constant. Evaluations of the effects of these and other
factors have not been completed, but the Company
estimates that the total cost recognized for pensions in
2005 will be approximately $12 million to $20 million
higher than the amount recorded in 2004.
The Company has pension plan assets with a fair value
of approximately $1.8 billion at December 31, 2004. The
Company’s expected rate of return on pension plan
assets is 9.25%. The Company reviews this rate on a
regular basis. Under Statement of Financial Accounting
Standards No. 87, “Employer’s Accounting for Pensions”
(SFAS No. 87), the expected rate of return used in
pension cost recognition is a long-term rate of return;
therefore, the Company would adjust that return only if
its fundamental assessment of the debt and equity
markets changes or its investment policy changes
significantly. The Company believes that its pension
plans’ asset investment mix and historical performance
support the long-term rate of 9.25% being used. The
Company did not adjust the rate in response to short-
term market fluctuations such as the abnormally high
market return levels of the latter 1990s, recent years’
market declines and the market rebound in 2003 and
2004. A 0.25% change in the expected rate of return for
2004 would have changed 2004 pension costs by
approximately $4 million.
Another factor affecting the Company’s pension costs,
and sensitivity of the costs to plan asset performance, is
its selection of a method to determine the market-related
value of assets, i.e., the asset value to which the 9.25%
expected long-term rate of return is applied. SFAS No. 87
specifies that entities may use either fair value or an
averaging method that recognizes changes in fair value
over a period not to exceed five years, with the method
selected applied on a consistent basis from year to year.
The Company has historically used a five-year averaging
method. When the Company acquired Florida Progress
Corporation (Florida Progress) in 2000, it retained the
Florida Progress historical use of fair value to determine
market-related value for Florida Progress pension
assets. Changes in plan asset performance are reflected
in pension costs sooner under the fair value method than
the five-year averaging method, and, therefore, pension
costs tend to be more volatile using the fair value
method. For example, in 2004 the expected return for
assets subject to the averaging method was 2% lower
than in 2003, whereas the expected return for assets
subject to the fair value method was 24% higher than in
2003. Approximately 50% of the Company’s pension plan
assets is subject to each of the two methods.
LIQUIDITY AND CAPITAL RESOURCES
Overview
Progress Energy is a registered holding company and, as
such, has no operations of its own. The Company’s primary
cash needs at the holding company level are its common
stock dividend and interest expense and principal
payments on its $4.3 billion of senior unsecured debt. The
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Management’s Discussion and Analysis