NORTHROP GRUMMAN CORP /DE/ | 2013 | FY | 3


RETIREMENT BENEFITS
Plan Descriptions
Defined Benefit Pension Plans – The company sponsors several defined benefit pension plans in the U.S. covering the majority of its employees. Pension benefits for most employees are based on the employee’s years of service, age and compensation. It is the policy of the company to fund at least the minimum amount required for all qualified plans, using actuarial cost methods and assumptions acceptable under U.S. Government regulations, by making payments into benefit trusts separate from the company.
Defined Contribution Plans – The company also sponsors 401(k) defined contribution plans in which most employees are eligible to participate, including certain employees covered under collective bargaining agreements. Company contributions for most plans are based on a cash matching of employee contributions up to 4 percent of compensation. In addition to the 401(k) defined contribution benefit, certain employees hired after June 30, 2008, are eligible to participate in a defined contribution program in lieu of a defined benefit pension plan. The company’s contributions to these defined contribution plans for the years ended December 31, 2013, 2012 and 2011, were $285 million, $293 million and $297 million, respectively.
Non-U.S. Benefit Plans – The company sponsors several benefit plans for non-U.S. employees. These plans are designed to provide benefits appropriate to local practice and in accordance with local regulations. Some of these plans are funded using benefit trusts that are separate from the company.
Medical and Life Benefits – The company provides a portion of the costs for certain health care and life insurance benefits for a substantial number of its active and retired employees. Certain covered employees achieve eligibility to participate in these contributory plans upon retirement from active service if they meet specified age and years of service requirements. Qualifying dependents are also eligible for medical coverage. Approximately 62 percent of the company’s current pension retirees participate in the medical plans. The company reserves the right to amend or terminate the plans at any time. The company has capped the amount of its contributions to substantially all of its remaining post retirement medical and life benefit plans.
In addition to a company and employee cost-sharing feature, the plans also have provisions for deductibles, co-payments, coinsurance percentages, out-of-pocket limits, conformance to a schedule of reasonable fees, the use of managed care providers, and coordination of benefits with other plans. The plans also provide for a Medicare carve-out. Subsequent to January 1, 2005 (or earlier at some segments), newly hired employees are not eligible for post retirement medical and life benefits.
Summary Plan Results
The cost to the company of its retirement benefit plans in each of the three years ended December 31 is shown in the following table:
 
 
Year Ended December 31
 
 
Pension Benefits
 
Medical and
Life Benefits
$ in millions
 
2013
 
2012
 
2011
 
2013
 
2012
 
2011
Components of net periodic benefit cost
 
 
 
 
 
 
 
 
 
 
 
 
Service cost
 

$ 516

 

$ 522

 

$ 520

 

$ 36

 

$ 34

 

$ 32

Interest cost
 
1,117

 
1,184

 
1,223

 
96

 
109

 
114

Expected return on plan assets
 
(1,809
)
 
(1,708
)
 
(1,690
)
 
(75
)
 
(68
)
 
(62
)
Amortization of:
 
 
 
 
 
 
 
 
 
 
 
 
Prior service (credit) cost
 
(58
)
 
(58
)
 
23

 
(51
)
 
(51
)
 
(51
)
Net loss from previous years
 
608

 
427

 
162

 
30

 
21

 
17

Other
 

 
7

 

 

 

 
(6
)
Net periodic benefit cost
 

$ 374

 

$ 374

 

$ 238

 

$ 36

 

$ 45

 

$ 44


The table below summarizes the components of changes in unamortized benefit plan costs for the years ended December 31, 2013, 2012 and 2011:
 
Pension
 
Medical and
 
 
$ in millions
Benefits
 
Life Benefits
 
Total
Changes in unamortized benefit plan costs
 
 
 
 
 
 
Change in net actuarial loss
 

$2,687

 

$138

 

$2,825

Change in prior service cost
 
(608
)
 
6

 
(602
)
Amortization of:
 
 
 
 
 
 
Prior service (cost) credit
 
(23
)
 
51

 
28

Net loss from previous years
 
(162
)
 
(17
)
 
(179
)
Tax benefit related to above items
 
(752
)
 
(71
)
 
(823
)
Change in unamortized benefit plan costs – 2011
 

$1,142

 

$107

 

$1,249

Change in net actuarial loss
 

$2,353

 

$151

 

$2,504

Change in prior service cost
 
(2
)
 

 
(2
)
Amortization of:
 
 
 
 
 
 
Prior service credit
 
58

 
51

 
109

Net loss from previous years
 
(427
)
 
(21
)
 
(448
)
Tax benefit related to above items
 
(788
)
 
(72
)
 
(860
)
Change in unamortized benefit plan costs – 2012
 

$1,194

 

$109

 

$1,303

Change in net actuarial loss
 

($2,158
)
 

($280
)
 

($2,438
)
Amortization of:
 
 
 
 
 
 
Prior service credit
 
58

 
51

 
109

Net loss from previous years
 
(608
)
 
(30
)
 
(638
)
Tax expense related to above items
 
1,075

 
102

 
1,177

Change in unamortized benefit plan costs – 2013
 

($1,633
)
 

($157
)
 

($1,790
)

Unamortized benefit plan costs consist primarily of accumulated actuarial losses totaling $3.3 billion and $5.1 billion, both after tax, as of December 31, 2013 and 2012, respectively. The change in net actuarial loss from pension benefits in 2013 was primarily due to the increase in the discount rate assumption to 4.99 percent at December 31, 2013, from 4.12 percent at December 31, 2012.
In December 2011, the company adopted certain changes in its defined benefit pension plans designed to enable the company to remain competitive within its marketplace and provide the affordability its customers require. These changes represent modifications to the defined benefits available to employees hired prior to July 1, 2008, who retire beginning after December 31, 2012. As a result of these changes, the company recognized a reduction of approximately $640 million in its projected benefit obligations for the affected employee groups as of December 31, 2011. Due to these changes, certain nonqualified benefit plans experienced curtailments, however the net impact of these curtailment events was not material.
 
 
Pension
Benefits
 
Medical and Life
Benefits
$ in millions
 
2013
 
2012
 
2013
 
2012
Amounts recorded in accumulated other comprehensive loss
 
 
 
 
 
 
 
 
Net actuarial loss
 
($5,291
)
 

($8,057
)
 
($151
)
 
($461
)
Prior service credit
 
423

 
481

 
47

 
98

Income tax benefits related to above items
 
1,928

 
3,003

 
44

 
146

Unamortized benefit plan costs
 
($2,940
)
 

($4,573
)
 
($ 60
)
 
($217
)

The following tables set forth the funded status and amounts recognized in the consolidated statements of financial position for the company’s defined benefit pension and retiree health care and life insurance benefit plans. Pension benefits data includes the qualified plans, foreign plans, as well as 11 domestic unfunded non-qualified plans for benefits provided to directors, officers and certain employees. The company uses a December 31 measurement date for all of its plans.
 
 
Pension Benefits
 
Medical and
Life Benefits
$ in millions
 
2013
 
2012
 
2013
 
2012
Change in projected benefit obligation
 
 
 
 
 
 
 
 
Projected benefit obligation at beginning of year
 
$27,746

 
$24,129

 
$2,448

 
$2,235

Service cost
 
516

 
522

 
36

 
34

Interest cost
 
1,117

 
1,184

 
96

 
109

Participant contributions
 
12

 
12

 
77

 
81

Plan amendments
 

 
(1
)
 

 

Actuarial (gain) loss
 
(2,063
)
 
3,114

 
(219
)
 
202

Benefits paid
 
(1,365
)
 
(1,220
)
 
(227
)
 
(227
)
Other
 
9

 
6

 
13

 
14

Projected benefit obligation at end of year
 
$25,972

 
$27,746

 
$2,224

 
$2,448

 
 
Pension Benefits
 
Medical and
Life Benefits
$ in millions
 
2013
 
2012
 
2013
 
2012
Change in plan assets
 
 
 
 
 
 
 
 
Fair value of plan assets at beginning of year
 
$22,962

 
$21,340

 
$1,062

 

$ 946

Gain on plan assets
 
1,907

 
2,463

 
137

 
119

Employer contributions
 
579

 
366

 
114

 
129

Participant contributions
 
12

 
12

 
77

 
81

Benefits paid
 
(1,365
)
 
(1,220
)
 
(227
)
 
(227
)
Other
 
3

 
1

 
12

 
14

Fair value of plan assets at end of year
 
24,098

 
22,962

 
1,175

 
1,062

Funded status
 
($ 1,874
)
 

($4,784
)
 
($1,049
)
 
($1,386
)
Amounts recognized in the Consolidated Statements of Financial Position
 
 
 
 
 
 
 
 
Non-current assets
 

$ 117

 

$ 7

 

$ 72

 

$ 49

Current liability
 
(122
)
 
(111
)
 
(36
)
 
(30
)
Non-current liability
 
(1,869
)
 
(4,680
)
 
(1,085
)
 
(1,405
)

The following table shows those amounts expected to be recognized in net periodic benefit cost in 2014:
$ in millions
Pension Benefits
 
Medical and
Life Benefits
Amounts expected to be recognized in 2014 net periodic benefit cost
 
 
 
 
 
Net actuarial loss
 
$327

 
 
$ 9

Prior service credit
 
(59
)
 
 
(30
)

The accumulated benefit obligation for all defined benefit pension plans was $25.7 billion and $27.2 billion at December 31, 2013 and 2012, respectively.
Amounts for pension plans with accumulated benefit obligations in excess of fair value of plan assets are as follows: 
 
 
December 31
$ in millions
 
2013
 
2012
Projected benefit obligation
 

$24,129

 

$27,645

Accumulated benefit obligation
 
23,830

 
27,146

Fair value of plan assets
 
22,138

 
22,853


Plan Assumptions
On a weighted-average basis, the following assumptions were used to determine the benefit obligations and the net periodic benefit cost:
 
 
Pension Benefits  
 
Medical and
Life Benefits
  
 
2013
 
2012
 
2013
 
2012
Assumptions used to determine benefit obligation at December 31
 
 
 
 
 
 
 
 
Discount rate
 
4.99
%
 
4.12
%
 
4.90
%
 
4.02
%
Initial cash balance crediting rate assumed for the next year
 
3.90
%
 
3.00
%
 
 
 
 
Rate to which the cash balance crediting rate is assumed to increase (the ultimate rate)
 
4.70
%
 
4.25
%
 
 
 
 
Year that the cash balance crediting rate reaches the ultimate rate
 
2019

 
2018

 
 
 
 
Rate of compensation increase
 
3.00
%
 
2.75
%
 
 
 
 
Initial health care cost trend rate assumed for the next year
 
 
 
 
 
6.50
%
 
7.00
%
Rate to which the health care cost trend rate is assumed to decline (the ultimate trend rate)
 
 
 
 
 
5.00
%
 
5.00
%
Year that the health care cost trend rate reaches the ultimate trend rate
 
 
 
 
 
2017

 
2017

Assumptions used to determine benefit cost for the year ended December 31
 
 
 
 
 
 
 
 
Discount rate
 
4.12
%
 
5.03
%
 
4.02
%
 
5.02
%
Initial cash balance crediting rate assumed for the next year
 
3.00
%
 
3.25
%
 
 
 
 
Rate to which the cash balance crediting rate is assumed to increase (the ultimate rate)
 
4.25
%
 
4.50
%
 
 
 
 
Year that the cash balance crediting rate reaches the ultimate rate
 
2018

 
2017

 
 
 
 
Expected long-term return on plan assets
 
8.00
%
 
8.25
%
 
7.33
%
 
7.44
%
Rate of compensation increase
 
2.75
%
 
2.75
%
 
 
 
 
Initial health care cost trend rate assumed for the next year
 
 
 
 
 
7.00
%
 
7.50
%
Rate to which the health care cost trend rate is assumed to decline (the ultimate trend rate)
 
 
 
 
 
5.00
%
 
5.00
%
Year that the health care cost trend rate reaches the ultimate trend rate
 
 
 
 
 
2017

 
2017


The discount rate is generally based on the yield of high-quality corporate fixed-income investments. At the end of each year, the discount rate is primarily determined using a portfolio of high-quality bonds matching the notional cash inflows with the expected benefit payments for each significant benefit plan.
Through consultation with investment advisors, expected long-term returns for each of the plans’ strategic asset classes were developed. Several factors were considered, including current market data such as yields/price-earnings ratios, historical market returns over long periods and periodic surveys of investment managers’ expectations. Using policy target allocation percentages and the asset class expected returns, a weighted-average expected return was calculated.
The assumptions used for pension benefits are consistent with those used for retiree medical and life insurance benefits. The long-term rate of return on plan assets used for medical and life benefits is reduced to allow for the impact of tax on expected returns as the earnings of certain Voluntary Employee Beneficiary Association (VEBA) trusts are taxable, unlike the pension trust.
A one-percentage-point change in the initial through the ultimate health care cost trend rates would have had the following estimated effect on 2013 other post-retirement benefit results:
$ in millions
1-Percentage-
Point Decrease
 
1-Percentage-
Point Increase
Increase (decrease) from change in health care cost trend rates to
 
 
 
 
 
Total service and interest cost
 
 $
(5
)
 
 
 $
4

Other post-retirement benefit liability
 
(81
)
 
 
67


Plan Assets and Investment Policy
Plan assets are invested in various asset classes that are expected to produce a sufficient level of diversification and investment return over the long term. The investment goal is to exceed the assumed rate of return over the long term within reasonable and prudent levels of risk. Liability studies are conducted on a regular basis to provide guidance in setting investment goals with an objective to balance risk. Risk targets are established and monitored against acceptable ranges.
Our investment policies and procedures are designed to ensure the plans’ investments are in compliance with ERISA (Employee Retirement Income Security Act). Guidelines are established defining permitted investments within each asset class. Derivatives are used for transitioning assets, asset class rebalancing, managing currency risk and for management of fixed income and alternative investments.
For the majority of the plans’ assets, the investment policies require that the asset allocation be maintained within the following ranges as of December 31, 2013:
  
 
Asset Allocation Ranges
Domestic equities
 
10% - 30%
International equities
 
5% - 25%
Fixed income securities
 
30% - 50%
Alternative investments
 
15% - 30%

The table below provides the fair values of the company’s pension and VEBA trust plan assets at December 31, 2013, and 2012, by asset category. The table also identifies the level of inputs used to determine the fair value of assets in each category (see Note 1 for definition of levels). The significant amount of Level 2 investments in the table results from including in this category investments in pooled funds that contain investments with values based on quoted market prices, but for which the funds are not valued on a quoted market basis, and fixed income securities valued using model-based pricing services.
 
 
Level 1
 
Level 2
 
Level 3
 
Total
$ in millions
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
Asset category
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents(1)
 

$ 32

 

$ 92

 

$ 1,467

 

$ 1,748

 
 
 
 
 

$ 1,499

 

$ 1,840

Domestic equities
 
4,163

 
3,657

 
287

 
318

 
2

 

$ 2

 
4,452

 
3,977

International equities
 
2,473

 
1,700

 
1,741

 
2,319

 
 
 
 
 
4,214

 
4,019

Fixed income securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
 
 
 
 
1,602

 
1,780

 
 
 
 
 
1,602

 
1,780

U.S. Government Agency
 
 
 
 
 
974

 
968

 
 
 
 
 
974

 
968

Non-U.S. Government
 
 
 
 
 
422

 
401

 
 
 
 
 
422

 
401

Corporate debt
 
 
 
 
 
4,744

 
4,123

 
 
 
 
 
4,744

 
4,123

Asset backed
 
 
 
 
 
545

 
528

 
4

 
4

 
549

 
532

High yield debt
 
 
 
 
 
922

 
1,139

 
1

 
28

 
923

 
1,167

Bank loans
 
 
 
 
 
185

 
223

 
 
 
 
 
185

 
223

Alternative Investments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hedge funds
 
 
 
 
 
 
 
 
 
821

 
758

 
821

 
758

Private equities
 
 
 
 
 
 
 
 
 
2,075

 
1,980

 
2,075

 
1,980

Real estate
 
 
 
 
 
 
 
 
 
2,767

 
2,256

 
2,767

 
2,256

Other
 
26

 
(5
)
 
20

 
5

 
  
 
  
 
46

 

Fair value of plan assets at the end of the year
 

$6,694

 

$5,444

 

$12,909

 

$13,552

 

$5,670

 

$5,028

 

$25,273

 

$24,024


(1)
Cash and cash equivalents are predominantly held in money market funds.
The changes in the fair value of the pension and VEBA plan trust assets measured using Level 3 significant unobservable inputs during 2013 and 2012, are as follows:
$ in millions
 
Hedge funds and High-yield debt
 
Private equities
 
Real Estate
 
Other
 
Total
Balance as of December 31, 2011
 

$1,446

 

$2,098

 

$1,788

 

$6

 

$5,338

Actual return on plan assets:
 
 
 
 
 
 
 
 
 
 
Unrealized gains (losses), net
 
23

 
(122
)
 
68

 
5

 
(26
)
Realized gains (losses), net
 
47

 

 

 
(5
)
 
42

Purchases
 

 
259

 
846

 

 
1,105

Sales
 
(730
)
 
(255
)
 
(446
)
 

 
(1,431
)
Balance as of December 31, 2012
 

$ 786

 

$1,980

 

$2,256

 

$6

 

$5,028

Actual return on plan assets:
 
 
 
 
 
 
 
 
 
 
Unrealized gains (losses), net
 
(16
)
 
112

 
262

 

 
358

Realized gains (losses), net
 
43

 

 

 

 
43

Purchases
 
200

 
666

 
763

 

 
1,629

Sales
 
(191
)
 
(683
)
 
(514
)
 

 
(1,388
)
Balance as of December 31, 2013
 

$ 822

 

$2,075

 

$2,767

 

$6

 

$5,670


Generally, investments are valued based on information in financial publications of general circulation, statistical and valuation services, records of security exchanges, appraisal by qualified persons, transactions and bona fide offers. Domestic and international equities consist primarily of common stocks and institutional common trust funds. Investments in common and preferred shares are valued at the last reported sales price of the stock on the last business day of the reporting period. Units in common trust funds and hedge funds are valued based on the redemption price of units owned by the trusts at year-end. Fair value for real estate and private equity partnerships is primarily based on valuation methodologies that include third party appraisals, comparable transactions, discounted cash flow valuation models and public market data.
Non-government fixed income securities are invested across various industry sectors and credit quality ratings. Generally, investment guidelines are written to limit securities, for example, to no more than 5 percent of each trust account, and to exclude the purchase of securities issued by the company. The number of real estate and private equity partnerships is 163 and the unfunded commitments are $899 million and $810 million as of December 31, 2013 and 2012, respectively. For alternative investments that cannot be redeemed, such as limited partnerships, the typical investment term is ten years. For alternative investments that permit redemptions, such redemptions are generally made quarterly and require a 90-day notice. The company is generally unable to determine the final redemption date and amount until the request is processed by the investment fund and therefore categorizes such alternative investments as Level 3 assets.
For the years ended December 31, 2013 and 2012, the defined benefit pension and VEBA trusts did not hold any Northrop Grumman common stock.
Benefit Payments
The following table reflects estimated future benefit payments for the next ten years, based upon the same assumptions used to measure the benefit obligation, and includes expected future employee service, as of December 31, 2013:
$ in millions
 
Pension Plans
 
Medical and
Life Plans
Year Ending December 31
 
 
 
 
2014
 

$1,341

 

$148

2015
 
1,394

 
154

2016
 
1,446

 
160

2017
 
1,500

 
165

2018
 
1,557

 
169

2019 through 2023
 
8,556

 
860


In 2014, the company expects to contribute the required minimum funding level of approximately $74 million to its pension plans and approximately $90 million to its other post-retirement benefit plans, with no expected additional voluntary pension contributions. During the years ended December 31, 2013 and 2012, the company made voluntary pension contributions of $500 million and $300 million, respectively.

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