19. Employee Benefit Plans.
The Company sponsors various pension plans for the majority of its U.S. and non-U.S. employees. The Company provides certain other postretirement benefits, primarily health care and life insurance, to eligible U.S. employees. The Company also provides certain postemployment benefits to certain former employees or inactive employees prior to retirement.
Pension and Other Postretirement Plans. Substantially all of the U.S. employees of the Company and its U.S. affiliates who were hired before July 1, 2007 are covered by the U.S. pension plan, a non-contributory, defined benefit pension plan that is qualified under Section 401(a) of the Internal Revenue Code (the “U.S. Qualified Plan”). Unfunded supplementary plans (the “Supplemental Plans”) cover certain executives. In addition, certain of the Company's non-U.S. subsidiaries also have defined benefit pension plans covering substantially all of their employees. These pension plans generally provide pension benefits that are based on each employee's years of credited service and on compensation levels specified in the plans. The Company's policy is to fund at least the amounts sufficient to meet minimum funding requirements under applicable employee benefit and tax laws. Liabilities for benefits payable under the Supplemental Plans are accrued by the Company and are funded when paid to the participants and beneficiaries. The Company's U.S. Qualified Plan ceased future benefit accruals after December 31, 2010.
The Company also has an unfunded postretirement benefit plan that provides medical and life insurance for eligible U.S. retirees and medical insurance for their dependents.
Net Periodic Benefit Expense.
The following table presents the components of the net periodic benefit expense (income) for 2013, 2012 and 2011:
Pension | Postretirement | ||||||||||||
2013 | 2012 | 2011 | 2013 | 2012 | 2011 | ||||||||
(dollars in millions) | |||||||||||||
Service cost, benefits earned during the period | $ | 23 | $ | 26 | $ | 27 | $ | 4 | $ | 4 | $ | 4 | |
Interest cost on projected benefit obligation | 151 | 156 | 158 | 7 | 7 | 8 | |||||||
Expected return on plan assets | (114) | (110) | (131) | — | — | — | |||||||
Net amortization of prior service cost (credit) | — | — | — | (13) | (14) | (14) | |||||||
Net amortization of actuarial loss | 36 | 27 | 17 | 3 | 2 | 2 | |||||||
Settlement loss | 1 | — | 1 | — | — | — | |||||||
Net periodic benefit expense (income) | $ | 97 | $ | 99 | $ | 72 | $ | 1 | $ | (1) | $ | — |
Other changes in plan assets and benefit obligations recognized in other comprehensive loss (income) on a pre-tax basis in 2013, 2012 and 2011 were as follows:
Pension | Postretirement | ||||||||||||
2013 | 2012 | 2011 | 2013 | 2012 | 2011 | ||||||||
(dollars in millions) | |||||||||||||
Net loss (gain) | $ | 87 | $ | 416 | $ | (401) | $ | (52) | $ | 16 | $ | (5) | |
Prior service cost | 3 | 3 | 2 | — | — | — | |||||||
Amortization of prior service credit | — | — | — | 13 | 14 | 14 | |||||||
Amortization of net loss | (37) | (27) | (18) | (3) | (2) | (2) | |||||||
Total recognized in other comprehensive loss (income) | $ | 53 | $ | 392 | $ | (417) | $ | (42) | $ | 28 | $ | 7 |
The Company, for most plans, amortizes (as a component of net periodic benefit expense) unrecognized net gains and losses over the average future service of active participants to the extent that the gain (loss) exceeds 10% of the greater of the projected benefit obligation or the market-related value of plan assets. Effective January 1, 2011, the U.S. Qualified Plan amortizes the unrecognized net gains and losses using the average life expectancy of participants.
The following table presents the weighted average assumptions used to determine net periodic benefit expense for 2013, 2012 and 2011:
Pension | Postretirement | ||||||||||||
2013 | 2012 | 2011 | 2013 | 2012 | 2011 | ||||||||
Discount rate | 3.95% | 4.57% | 5.44% | 3.88% | 4.56% | 5.41% | |||||||
Expected long-term rate of | |||||||||||||
return on plan assets | 3.73 | 3.78 | 4.78 | N/A | N/A | N/A | |||||||
Rate of future compensation increases | 0.98 | 2.14 | 2.28 | N/A | N/A | N/A |
________
N/A—Not Applicable.
The expected long-term rate of return on plan assets represents the Company's best estimate of the long-term return on plan assets. For the U.S. Qualified Plan, the expected long-term rate of return was estimated by computing a weighted average return of the underlying long-term expected returns on the plan's fixed income assets based on the investment managers' target allocations within this asset class. The expected long-term return on assets is a long-term assumption that generally is expected to remain the same from one year to the next unless there is a significant change in the target asset allocation, the fees and expenses paid by the plan or market conditions. The U.S. Qualified Plan is 100% invested in fixed income securities and related derivative instruments, including interest rate swap contracts. This asset allocation is expected to help protect the plan's funded status and limit volatility of the Company's contributions. Total U.S. Qualified Plan investment portfolio performance is assessed by comparing actual investment performance to changes in the estimated present value of the U.S. Qualified Plan's benefit obligation.
Benefit Obligations and Funded Status.
The following table provides a reconciliation of the changes in the benefit obligation and fair value of plan assets for 2013 and 2012:
Pension | Postretirement | ||||
(dollars in millions) | |||||
Reconciliation of benefit obligation: | |||||
Benefit obligation at December 31, 2011 | $ | 3,517 | $ | 154 | |
Service cost | 26 | 4 | |||
Interest cost | 156 | 7 | |||
Actuarial loss | 405 | 15 | |||
Plan settlements | (2) | — | |||
Benefits paid | (147) | (6) | |||
Other, including foreign currency exchange rate changes | (72) | — | |||
Benefit obligation at December 31, 2012 | $ | 3,883 | $ | 174 | |
Service cost | 23 | 4 | |||
Interest cost | 151 | 7 | |||
Actuarial gain | (537) | (52) | |||
Plan amendments | 2 | — | |||
Plan settlements | (7) | — | |||
Benefits paid | (186) | (6) | |||
Other, including foreign currency exchange rate changes | 1 | 1 | |||
Benefit obligation at December 31, 2013 | $ | 3,330 | $ | 128 | |
Reconciliation of fair value of plan assets: | |||||
Fair value of plan assets at December 31, 2011 | $ | 3,604 | $ | — | |
Actual return on plan assets | 83 | — | |||
Employer contributions | 42 | 6 | |||
Benefits paid | (147) | (6) | |||
Plan settlements | (2) | — | |||
Other, including foreign currency exchange rate changes | (61) | — | |||
Fair value of plan assets at December 31, 2012 | $ | 3,519 | $ | — | |
Actual return on plan assets | (512) | — | |||
Employer contributions | 42 | 6 | |||
Benefits paid | (186) | (6) | |||
Plan settlements | (7) | — | |||
Other, including foreign currency exchange rate changes | 11 | — | |||
Fair value of plan assets at December 31, 2013 | $ | 2,867 | $ | — |
The following table presents a summary of the funded status at December 31, 2013 and December 31, 2012:
Pension | Postretirement | |||||||||
December 31, 2013 | December 31, 2012 | December 31, 2013 | December 31, 2012 | |||||||
(dollars in millions) | ||||||||||
Funded (unfunded) status | $ | (463) | $ | (364) | $ | (128) | $ | (174) | ||
Amounts recognized in the consolidated statements of financial | ||||||||||
condition consist of: | ||||||||||
Assets | $ | 60 | $ | 97 | $ | — | $ | — | ||
Liabilities | (523) | (461) | (128) | (174) | ||||||
Net amount recognized | $ | (463) | $ | (364) | $ | (128) | $ | (174) | ||
Amounts recognized in accumulated other comprehensive loss | ||||||||||
consist of: | ||||||||||
Prior-service cost (credit) | $ | 1 | $ | (2) | $ | (11) | $ | (24) | ||
Net loss (gain) | 871 | 821 | (14) | 41 | ||||||
Net loss (gain) recognized | $ | 872 | $ | 819 | $ | (25) | $ | 17 |
The estimated prior-service cost (credit) that will be amortized from accumulated other comprehensive loss into net periodic benefit expense over 2014 is $11 million for postretirement plans. The estimated net loss that will be amortized from accumulated other comprehensive loss into net periodic benefit expense over 2014 is approximately $21 million for defined benefit pension plans.
The accumulated benefit obligation for all defined benefit pension plans was $3,309 million and $3,858 million at December 31, 2013 and December 31, 2012, respectively.
The following table contains information for pension plans with projected benefit obligations in excess of the fair value of plan assets at period-end:
December 31, 2013 | December 31, 2012 | ||||
(dollars in millions) | |||||
Projected benefit obligation | $ | 3,127 | $ | 552 | |
Fair value of plan assets | 2,603 | 90 |
The following table contains information for pension plans with accumulated benefit obligations in excess of the fair value of plan assets at period-end:
December 31, 2013 | December 31, 2012 | ||||
(dollars in millions) | |||||
Accumulated benefit obligation | $ | 3,089 | $ | 527 | |
Fair value of plan assets | 2,586 | 90 |
The following table presents the weighted average assumptions used to determine benefit obligations at period-end:
Pension | Postretirement | |||||||
December 31, 2013 | December 31, 2012 | December 31, 2013 | December 31, 2012 | |||||
Discount rate | 4.74% | 3.95% | 4.75% | 3.88% | ||||
Rate of future compensation increase | 1.06 | 0.98 | N/A | N/A |
_______
N/A—Not Applicable.
The discount rates used to determine the benefit obligations for the U.S. pension, U.S. postretirement and the U.K. pension plans' liabilities were selected by the Company, in consultation with its independent actuaries, using a pension discount yield curve based on the characteristics of the plans, each determined independently. The pension discount yield curve represents spot discount yields based on duration implicit in a representative broad-based Aa rated corporate bond universe of high-quality fixed income investments. For all other non-U.S. pension plans, the Company set the assumed discount rates based on the nature of liabilities, local economic environments and available bond indices.
The following table presents assumed health care cost trend rates used to determine the U.S. postretirement benefit obligations at period-end:
December 31, 2013 | December 31, 2012 | |||
Health care cost trend rate assumed for next year: | ||||
Medical | 6.90-7.38% | 6.93-7.53% | ||
Prescription | 8.25% | 8.66% | ||
Rate to which the cost trend rate is assumed to decline (ultimate trend rate) | 4.50% | 4.50% | ||
Year that the rate reaches the ultimate trend rate | 2029 | 2029 |
Assumed health care cost trend rates can have a significant effect on the amounts reported for the Company's postretirement benefit plan. A one-percentage point change in assumed health care cost trend rates would have the following effects:
One-Percentage Point Increase | One-Percentage Point (Decrease) | ||||
(dollars in millions) | |||||
Effect on total postretirement service and interest cost | $ | 2 | $ | (1) | |
Effect on postretirement benefit obligation | 19 | (11) |
No impact of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 has been reflected in the Company's consolidated statements of income as Medicare prescription drug coverage was deemed to have no material effect on the Company's postretirement benefit plan.
Plan Assets. The U.S. Qualified Plan assets represent 87% of the Company's total pension plan assets. The U.S. Qualified Plan uses a combination of active and risk-controlled fixed income investment strategies. The fixed income asset allocation consists primarily of fixed income securities designed to approximate the expected cash flows of the plan's liabilities in order to help reduce plan exposure to interest rate variation and to better align assets with obligations. The longer duration fixed income allocation is expected to help protect the plan's funded status and maintain the stability of plan contributions over the long run.
The allocation among investment managers of the Company's U.S. Qualified Plan is reviewed by the Morgan Stanley Retirement Plan Investment Committee (the “Investment Committee”) on a regular basis. When the exposure to a given investment manager reaches a minimum or maximum allocation level, an asset allocation review process is initiated, and the portfolio will be rebalanced toward the target allocation unless the Investment Committee determines otherwise.
Derivative instruments are permitted in the U.S. Qualified Plan's investment portfolio only to the extent that they comply with all of the plan's policy guidelines and are consistent with the plan's risk and return objectives. In addition, any investment in derivatives must meet the following conditions:
• Derivatives may be used only if they are deemed by the investment manager to be more attractive than a similar direct investment in the underlying cash market or if the vehicle is being used to manage risk of the portfolio.
• Derivatives may not be used in a speculative manner or to leverage the portfolio under any circumstances.
• Derivatives may not be used as short-term trading vehicles. The investment philosophy of the U.S. Qualified Plan is that investment activity is undertaken for long-term investment rather than short-term trading.
• Derivatives may be used in the management of the U.S. Qualified Plan's portfolio only when their possible effects can be quantified, shown to enhance the risk-return profile of the portfolio, and reported in a meaningful and understandable manner.
As a fundamental operating principle, any restrictions on the underlying assets apply to a respective derivative product. This includes percentage allocations and credit quality. Derivatives will be used solely for the purpose of enhancing investment in the underlying assets and not to circumvent portfolio restrictions.
Plan assets are measured at fair value using valuation techniques that are consistent with the valuation techniques applied to the Company's major categories of assets and liabilities as described in Note 4. Quoted market prices in active markets are the best evidence of fair value and are used as the basis for the measurement, if available. If a quoted market price is available, the fair value is the product of the number of trading units multiplied by the market price. If a quoted market price is not available, the estimate of fair value is based on the valuation approaches that maximize use of observable inputs and minimize use of unobservable inputs.
The fair value of OTC derivative contracts is derived primarily using pricing models, which may require multiple market input parameters. Derivative contracts are presented on a gross basis prior to cash collateral or counterparty netting. Derivatives consist of investments in interest rate swap contracts and are categorized as Level 2 of the fair value hierarchy.
Commingled trust funds are privately offered funds available to institutional clients that are regulated, supervised and subject to periodic examination by a U.S. federal or state agency. The trust must be maintained for the collective investment or reinvestment of assets contributed to it from employee benefit plans maintained by more than one employer or a controlled group of corporations. The sponsor of the commingled trust funds values the funds' NAV based on the fair value of the underlying securities. The underlying securities of the commingled trust funds consist of mainly long-duration fixed income instruments. Commingled trust funds that are redeemable at the measurement date or in the near future are categorized in Level 2 of the fair value hierarchy, otherwise they are categorized in Level 3 of the fair value hierarchy.
Some non-U.S.-based plans hold foreign funds that consist of investments in foreign corporate equity funds, foreign corporate bond funds, foreign target cash flow funds and foreign liquidity funds. Foreign corporate equity funds and foreign corporate bond funds invest in individual securities quoted on a recognized stock exchange or traded in a regulated market and certain bond funds that aim to produce returns as close as possible to certain Financial Times Stock Exchange indexes. Foreign target cash flow funds are designed to provide a series of fixed annual cash flows over five or 10 years achieved by investing in government bonds and derivatives. Foreign liquidity funds place a high priority on capital preservation, stable value and a high liquidity of assets. Foreign funds are generally categorized in Level 2 of the fair value hierarchy as they are readily redeemable at their NAV. Corporate equity funds traded on a recognized exchange are categorized in Level 1 of the fair value hierarchy.
Other investments held by non-U.S. based plans consist of real estate funds, hedge funds and insurance annuity contracts. These real estate and hedge funds are categorized in Level 2 of the fair value hierarchy to the extent that they are readily redeemable at their NAV, otherwise they are categorized in Level 3 of the fair value hierarchy. The insurance annuity contracts are valued based on the premium reserve of the insurer for a guarantee that the insurer has given to the employee benefit plan that approximates fair value. The insurance annuity contracts are categorized in Level 3 of the fair value hierarchy.
The following table presents the fair value of the net pension plan assets at December 31, 2013. There were no transfers between levels during 2013:
Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total | |||||||
(dollars in millions) | ||||||||||
Assets: | ||||||||||
Investments: | ||||||||||
Cash and cash equivalents(1) | $ | 91 | $ | — | $ | — | $ | 91 | ||
U.S. government and agency securities: | ||||||||||
U.S. Treasury securities | 1,047 | — | — | 1,047 | ||||||
U.S. agency securities | — | 204 | — | 204 | ||||||
Total U.S. government and agency securities | 1,047 | 204 | — | 1,251 | ||||||
Corporate and other debt: | ||||||||||
State and municipal securities | — | 2 | — | 2 | ||||||
Collateralized debt obligations | — | 76 | — | 76 | ||||||
Total corporate and other debt | — | 78 | — | 78 | ||||||
Derivative contracts(2) | — | 122 | — | 122 | ||||||
Derivative-related cash collateral receivable | — | 37 | — | 37 | ||||||
Commingled trust funds(3) | — | 1,004 | — | 1,004 | ||||||
Foreign funds(4) | 21 | 291 | — | 312 | ||||||
Other investments | — | 10 | 38 | 48 | ||||||
Total investments | 1,159 | 1,746 | 38 | 2,943 | ||||||
Receivables: | ||||||||||
Other receivables(1) | — | 20 | — | 20 | ||||||
Total receivables | — | 20 | — | 20 | ||||||
Total assets | $ | 1,159 | $ | 1,766 | $ | 38 | $ | 2,963 | ||
Liabilities: | ||||||||||
Derivative contracts(5) | $ | — | $ | 92 | $ | — | $ | 92 | ||
Derivative-related cash collateral payable | — | 2 | — | 2 | ||||||
Other liabilities(1) | — | 2 | — | 2 | ||||||
Total liabilities | — | 96 | — | 96 | ||||||
Net pension assets | $ | 1,159 | $ | 1,670 | $ | 38 | $ | 2,867 |
_______________________
(1) Cash and cash equivalents, other receivables and other liabilities are valued at their carrying value, which approximates fair value.
(2) Derivative contracts in an asset position consist of investments in interest rate swaps of $122 million.
(3) Commingled trust funds consist of investments in fixed income funds of $1,004 million.
(4) Foreign funds include investments in corporate bond funds, targeted cash flow funds, liquidity funds, corporate equity funds and diversified funds of $157 million, $77 million, $56 million, $21 million and $1 million, respectively.
(5) Derivative contracts in a liability position consist of investments in interest rate swaps of $92 million.
The following table presents the fair value of the net pension plan assets at December 31, 2012. There were no transfers between levels during 2012:
Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total | |||||||
(dollars in millions) | ||||||||||
Assets: | ||||||||||
Investments: | ||||||||||
Cash and cash equivalents(1) | $ | 80 | $ | — | $ | — | $ | 80 | ||
U.S. government and agency securities: | ||||||||||
U.S. Treasury securities | 1,354 | — | — | 1,354 | ||||||
U.S. agency securities | — | 241 | — | 241 | ||||||
Total U.S. government and agency securities | 1,354 | 241 | — | 1,595 | ||||||
Corporate and other debt: | ||||||||||
State and municipal securities | — | 2 | — | 2 | ||||||
Collateralized debt obligations | — | 71 | — | 71 | ||||||
Total corporate and other debt | — | 73 | — | 73 | ||||||
Corporate equities | 20 | — | — | 20 | ||||||
Derivative contracts(2) | — | 224 | — | 224 | ||||||
Derivative-related cash collateral receivable | — | 3 | — | 3 | ||||||
Commingled trust funds(3) | — | 1,275 | — | 1,275 | ||||||
Foreign funds(4) | — | 282 | — | 282 | ||||||
Other investments | — | 11 | 30 | 41 | ||||||
Total investments | 1,454 | 2,109 | 30 | 3,593 | ||||||
Receivables: | ||||||||||
Other receivables(1) | — | 71 | — | 71 | ||||||
Total receivables | — | 71 | — | 71 | ||||||
Total assets | $ | 1,454 | $ | 2,180 | $ | 30 | $ | 3,664 | ||
Liabilities: | ||||||||||
Derivative contracts(5) | $ | — | $ | 57 | $ | — | $ | 57 | ||
Derivative-related cash collateral payable | — | 28 | — | 28 | ||||||
Other liabilities(1) | — | 60 | — | 60 | ||||||
Total liabilities | — | 145 | — | 145 | ||||||
Net pension assets | $ | 1,454 | $ | 2,035 | $ | 30 | $ | 3,519 |
________________________
(1) Cash and cash equivalents, other receivables and other liabilities are valued at their carrying value, which approximates fair value.
(2) Derivative contracts in an asset position consist of investments in interest rate swaps of $224 million.
(3) Commingled trust funds consist of investments in fixed income funds of $1,275 million.
(4) Foreign funds include investments in corporate bond funds, targeted cash flow funds, liquidity funds and diversified funds of $141 million, $85 million, $55 million and $1 million, respectively.
(5) Derivative contracts in a liability position consist of investments in interest rate swaps of $57 million.
The following table presents changes in Level 3 pension assets measured at fair value for 2013:
Beginning Balance at January 1, 2013 | Actual Return on Plan Assets Related to Assets Still Held at December 31, 2013 | Actual Return on Plan Assets Related to Assets Sold during 2013 | Purchases, Sales, Other Settlements and Issuances, net | Net Transfers In and/or (Out) of Level 3 | Ending Balance at December 31, 2013 | |||||||||
(dollars in millions) | ||||||||||||||
Investments | ||||||||||||||
Other investments | $ | 30 | $ | 2 | $ | — | $ | 4 | $ | 2 | $ | 38 | ||
Total investments | $ | 30 | $ | 2 | $ | — | $ | 4 | $ | 2 | $ | 38 |
The following table presents changes in Level 3 pension assets measured at fair value for 2012:
Beginning Balance at January 1, 2012 | Actual Return on Plan Assets Related to Assets Still Held at December 31, 2012 | Actual Return on Plan Assets Related to Assets Sold during 2012 | Purchases, Sales, Other Settlements and Issuances, net | Net Transfers In and/or (Out) of Level 3 | Ending Balance at December 31, 2012 | |||||||||
(dollars in millions) | ||||||||||||||
Investments | ||||||||||||||
Other investments | $ | 26 | $ | — | $ | — | $ | 4 | $ | — | $ | 30 | ||
Total investments | $ | 26 | $ | — | $ | — | $ | 4 | $ | — | $ | 30 |
Cash Flows.
At December 31, 2013, the Company expects to contribute approximately $50 million to its pension and postretirement benefit plans in 2014 based upon the plans' current funded status and expected asset return assumptions for 2014, as applicable.
Expected benefit payments associated with the Company's pension and postretirement benefit plans for the next five years and in aggregate for the five years thereafter at December 31, 2013 are as follows:
Pension | Postretirement | ||||
(dollars in millions) | |||||
2014 | $ | 129 | $ | 6 | |
2015 | 128 | 6 | |||
2016 | 130 | 6 | |||
2017 | 138 | 7 | |||
2018 | 137 | 7 | |||
2019-2023 | 788 | 40 |
Morgan Stanley 401(k) Plan. U.S. employees meeting certain eligibility requirements may participate in the Morgan Stanley 401(k) Plan. Eligible U.S. employees receive 401(k) matching cash contributions representing a $1 for $1 Company match up to 4% of eligible pay, up to the Internal Revenue Service (“IRS”) limit. Matching contributions for 2013 and 2012 were allocated according to participants' current investment direction. Eligible U.S. employees with eligible pay less than or equal to $100,000 also receive a fixed contribution under the 401(k) Plan that equals 2% of eligible pay. A transition contribution is allocated to participants who received a 2010 accrual in the U.S. Qualified Plan or a 2010 retirement contribution in the 401(k) Plan and who met certain age and service requirements as of December 31, 2010.
A separate transition contribution is allocated to certain eligible legacy Smith Barney employees. The Company match, fixed contribution and transition contributions are included in the Company's 401(k) expense. The pre-tax 401(k) expense for 2013, 2012 and 2011 was $242 million, $246 million and $257 million, respectively.
Defined Contribution Pension Plans. The Company maintains separate defined contribution pension plans that cover substantially all employees of certain non-U.S. subsidiaries. Under such plans, benefits are determined based on a fixed rate of base salary with certain vesting requirements. In 2013, 2012 and 2011, the Company's expense related to these plans was $111 million, $126 million and $136 million, respectively.
Other Postemployment Benefits. Postemployment benefits may include, but are not limited to, salary continuation, severance benefits, disability-related benefits, and continuation of health care and life insurance coverage provided to former employees or inactive employees after employment but before retirement. The postemployment benefit obligations were not material at December 31, 2013 and December 31, 2012.