DOW CHEMICAL CO /DE/ | 2013 | FY | 3


PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS

Pension Plans
The Company has defined benefit pension plans that cover employees in the United States and a number of other countries. The U.S. qualified plan covering the parent company is the largest plan. Benefits for employees hired before January 1, 2008 are based on length of service and the employee’s three highest consecutive years of compensation. Employees hired after January 1, 2008 earn benefits that are based on a set percentage of annual pay, plus interest.

The Company’s funding policy is to contribute to the plans when pension laws and/or economics either require or encourage funding. In 2013, Dow contributed $865 million to its pension plans, including contributions to fund benefit payments for its non-qualified supplemental plans. Dow expects to contribute approximately $800 million to its pension plans in 2014.

The weighted-average assumptions used to determine pension plan obligations and net periodic benefit costs for the plans are provided in the two tables below:

Weighted-Average Assumptions
for All Pension Plans
 
Benefit Obligations
at December 31
 
Net Periodic Costs
for the Year
  
 
2013

 
2012

 
2011

 
2013

 
2012

 
2011

Discount rate
 
4.54
%
 
3.88
%
 
4.93
%
 
3.88
%
 
4.93
%
 
5.38
%
Rate of increase in future compensation levels
 
4.15
%
 
3.96
%
 
4.14
%
 
3.96
%
 
4.14
%
 
4.16
%
Expected long-term rate of return on plan assets
 

 

 

 
7.47
%
 
7.60
%
 
7.86
%



Weighted-Average Assumptions
for U.S. Pension Plans
 
Benefit Obligations
at December 31
 
Net Periodic Costs
for the Year
  
 
2013

 
2012

 
2011

 
2013

 
2012

 
2011

Discount rate
 
4.92
%
 
4.02
%
 
4.98
%
 
4.02
%
 
4.98
%
 
5.51
%
Rate of increase in future compensation levels
 
4.50
%
 
4.50
%
 
4.50
%
 
4.50
%
 
4.50
%
 
4.50
%
Expected long-term rate of return on plan assets
 

 

 

 
7.85
%
 
7.83
%
 
8.18
%


The Company determines the expected long-term rate of return on plan assets by performing a detailed analysis of key economic and market factors driving historical returns for each asset class and formulating a projected return based on factors in the current environment. Factors considered include, but are not limited to, inflation, real economic growth, interest rate yield, interest rate spreads, and other valuation measures and market metrics. The expected long-term rate of return for each asset class is then weighted based on the strategic asset allocation approved by the governing body for each plan. The Company’s historical experience with the pension fund asset performance is also considered. The discount rates utilized to measure the pension and other postretirement obligations of the U.S. qualified plans are based on the yield on high-quality fixed income investments at the measurement date. Future expected actuarially determined cash flows of Dow’s major U.S. plans are matched against the Towers Watson RATE:Link yield curve (based on 60th to 90th percentile bond yields) to arrive at a single discount rate for each plan.

The accumulated benefit obligation for all defined benefit pension plans was $23.8 billion at December 31, 2013 and $25.3 billion at December 31, 2012.

Pension Plans with Accumulated Benefit Obligations in Excess
of Plan Assets at December 31
In millions
 
2013

 
2012

Projected benefit obligations
 
$
22,565

 
$
24,659

Accumulated benefit obligations
 
$
21,554

 
$
23,422

Fair value of plan assets
 
$
16,247

 
$
15,458



In addition to the U.S. qualified defined benefit pension plan, U.S. employees may participate in defined contribution plans (Employee Savings Plans or 401(k) plans) by contributing a portion of their compensation, which is partially matched by the Company. Defined contribution plans also cover employees in some subsidiaries in other countries, including Australia, Brazil, Canada, Italy, Spain and the United Kingdom. Expense recognized for all defined contribution plans was $231 million in 2013, $186 million in 2012 and $163 million in 2011.

Other Postretirement Benefits
The Company provides certain health care and life insurance benefits to retired employees. The Company’s plans outside of the United States are not significant; therefore, this discussion relates to the U.S. plans only. The plans provide health care benefits, including hospital, physicians’ services, drug and major medical expense coverage, and life insurance benefits. In general, for employees hired before January 1, 1993, the plans provide benefits supplemental to Medicare when retirees are eligible for these benefits. The Company and the retiree share the cost of these benefits, with the Company portion increasing as the retiree has increased years of credited service, although there is a cap on the Company portion. The Company has the ability to change these benefits at any time. Employees hired after January 1, 2008 are not covered under the plans.

During the fourth quarter 2013, the Company started implementing an Employer Group Waiver Plan (“EGWP”) for its Medicare-eligible, retiree medical plan participants, which became effective on January 1, 2014. As a result, the Medicare Part D Retiree Drug Subsidy program (“RDS”) was eliminated on January 1, 2014. The EGWP does not significantly alter the benefits provided to retiree medical plan participants. The federal subsidies to be earned under the EGWP are expected to exceed those earned under the RDS and will be partially offset by increased costs related to the administration of the EGWP. The formation of the EGWP and the resulting change in assumption generated an actuarial gain of $250 million at December 31, 2013, included in "Accumulated other comprehensive loss" in the consolidated balance sheets. The Company also recognized a reduction in the postretirement benefit obligation of $250 million at December 31, 2013. The Company estimates net periodic benefit cost will decrease by approximately $25 million in 2014 due to the EGWP.

The Company funds most of the cost of these health care and life insurance benefits as incurred. In 2013, Dow did not make any contributions to its other postretirement benefit plan trusts. The trusts did not hold assets at December 31, 2013. Dow does not expect to contribute assets to its other postretirement benefits plan trusts in 2014.

The weighted-average assumptions used to determine other postretirement benefit obligations and net periodic benefit costs for the U.S. plans are provided below:

U.S. Plan Assumptions for Other
Postretirement Benefits
 
Benefit Obligations
at December 31
 
Net Periodic Costs
for the Year
  
 
2013

 
2012

 
2011

 
2013

 
2012

 
2011

Discount rate
 
4.37
%
 
3.67
%
 
4.66
%
 
3.67
%
 
4.66
%
 
5.15
%
Expected long-term rate of return on plan assets
 

 

 

 
%
 
1.00
%
 
3.60
%
Initial health care cost trend rate
 
7.45
%
 
7.84
%
 
8.28
%
 
7.84
%
 
8.28
%
 
8.70
%
Ultimate health care cost trend rate
 
5.00
%
 
5.00
%
 
5.00
%
 
5.00
%
 
5.00
%
 
5.00
%
Year ultimate trend rate to be reached
 
2020

 
2019

 
2019

 
2020

 
2019

 
2019



Increasing the assumed medical cost trend rate by one percentage point in each year would decrease the accumulated postretirement benefit obligation at December 31, 2013 by $25 million and decrease the net periodic postretirement benefit cost for the year by $1 million. Decreasing the assumed medical cost trend rate by one percentage point in each year would increase the accumulated postretirement benefit obligation at December 31, 2013 by $29 million and the net periodic postretirement benefit cost for the year by $1 million.

Net Periodic Benefit Cost for All Significant Plans
 
 
Defined Benefit Pension Plans
 
Other Postretirement Benefits
In millions
 
2013

 
2012

 
2011

 
2013

 
2012

 
2011

Service cost
 
$
471

 
$
378

 
$
347

 
$
19

 
$
17

 
$
15

Interest cost
 
1,012

 
1,093

 
1,121

 
78

 
92

 
100

Expected return on plan assets
 
(1,248
)
 
(1,262
)
 
(1,305
)
 

 
(1
)
 
(6
)
Amortization of prior service cost (credit)
 
25

 
26

 
28

 
(4
)
 
(4
)
 
(1
)
Amortization of unrecognized loss
 
788

 
519

 
374

 
4

 
1

 
1

Curtailment/settlement/other (1) (2)
 
5

 

 
(4
)
 

 
9

 

Net periodic benefit cost
 
$
1,053

 
$
754

 
$
561

 
$
97

 
$
114

 
$
109


(1)
Included $9 million of curtailment costs recorded in 2012 related to the 4Q12 Restructuring plan (see Note 3).
(2)
The 2013 impact primarily relates to settlements associated with the wind-up of a Canadian pension plan.


Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive (Income) Loss
for All Significant Plans
 
 
Defined Benefit Pension Plans
 
Other Postretirement Benefits
In millions
 
2013

 
2012

 
2011

 
2013

 
2012

 
2011

Net (gain) loss
 
$
(2,343
)
 
$
3,135

 
$
2,009

 
$
(404
)
 
$
163

 
$
20

Amortization of prior service (cost) credit
 
(25
)
 
(26
)
 
(28
)
 
4

 
4

 
1

Amortization of unrecognized loss
 
(793
)
 
(519
)
 
(370
)
 
(4
)
 
(1
)
 
(1
)
Total recognized in other comprehensive (income) loss
 
$
(3,161
)
 
$
2,590

 
$
1,611

 
$
(404
)
 
$
166

 
$
20

Total recognized in net periodic benefit cost and other comprehensive (income) loss
 
$
(2,108
)
 
$
3,344

 
$
2,172

 
$
(307
)
 
$
280

 
$
129



Change in Projected Benefit Obligations, Plan Assets and Funded Status of All Significant Plans
In millions
 
Defined
Benefit Pension  Plans
 
Other Postretirement Benefits
Change in projected benefit obligations
 
2013

 
2012

 
2013

 
2012

Benefit obligations at beginning of year
 
$
26,840

 
$
22,763

 
$
2,210

 
$
2,088

Service cost
 
471

 
378

 
19

 
17

Interest cost
 
1,012

 
1,093

 
78

 
92

Plan participants’ contributions
 
17

 
38

 

 

Actuarial changes in assumptions and experience
 
(2,029
)
 
3,811

 
(401
)
 
164

Acquisition/divestiture/other activity
 

 
(51
)
 

 

Benefits paid
 
(1,322
)
 
(1,347
)
 
(156
)
 
(164
)
Currency impact
 
123

 
150

 
(8
)
 
4

Termination benefits/curtailment cost/settlements (1)
 
(85
)
 
5

 

 
9

Benefit obligations at end of year
 
$
25,027

 
$
26,840

 
$
1,742

 
$
2,210

 
 
 
 
 
 
 
 
 
Change in plan assets
 
 
 
 
 
 
 
 
Fair value of plan assets at beginning of year
 
$
17,725

 
$
16,119

 
$
65

 
$
154

Actual return on plan assets
 
1,548

 
1,950

 

 
1

Currency impact
 
85

 
129

 

 

Employer contributions
 
865

 
903

 

 
(10
)
Plan participants’ contributions
 
17

 
38

 

 

Acquisition/divestiture/other activity
 
(91
)
 
(67
)
 

 

Benefits paid
 
(1,322
)
 
(1,347
)
 
(65
)
 
(80
)
Fair value of plan assets at end of year
 
$
18,827

 
$
17,725

 
$

 
$
65

 
 
 
 
 
 
 
 
 
Funded status at end of year
 
$
(6,200
)
 
$
(9,115
)
 
$
(1,742
)
 
$
(2,145
)
 
 
 
 
 
 
 
 
 
Net amounts recognized in the consolidated balance sheets at December 31:
Noncurrent assets
 
$
139

 
$
92

 
$

 
$

Current liabilities
 
(66
)
 
(69
)
 
(157
)
 
(99
)
Noncurrent liabilities
 
(6,273
)
 
(9,138
)
 
(1,585
)
 
(2,046
)
Net amounts recognized in the consolidated balance sheets
 
$
(6,200
)
 
$
(9,115
)
 
$
(1,742
)
 
$
(2,145
)
 
 
 
 
 
 
 
 
 
Pretax amounts recognized in AOCI at December 31:
 
 
 
 
 
 
 
 
Net loss (gain)
 
$
7,815

 
$
10,951

 
$
(253
)
 
$
155

Prior service cost (credit)
 
103

 
128

 
(7
)
 
(11
)
Pretax balance in AOCI at end of year
 
$
7,918

 
$
11,079

 
$
(260
)
 
$
144


(1)    The 2013 impact primarily relates to settlements associated with the wind-up of a Canadian pension plan.

In 2014, an estimated net loss of $507 million and prior service cost of $23 million for the defined benefit pension plans will be amortized from AOCI to net periodic benefit cost. In 2014, an estimated net gain of $14 million and prior service credit of $2 million for other postretirement benefit plans will be amortized from AOCI to net periodic benefit cost.

Estimated Future Benefit Payments
The estimated future benefit payments, reflecting expected future service, as appropriate, are presented in the following table:

Estimated Future Benefit Payments at December 31, 2013
In millions
 
Defined Benefit Pension Plans

 
Other Postretirement Benefits

2014
 
$
1,263

 
$
160

2015
 
1,280

 
157

2016
 
1,305

 
152

2017
 
1,333

 
145

2018
 
1,378

 
141

2019 through 2023
 
7,401

 
636

Total
 
$
13,960

 
$
1,391


Plan Assets
Plan assets consist mainly of equity and fixed income securities of U.S. and foreign issuers, and include alternative investments such as real estate, private equity and absolute return strategies. At December 31, 2013, plan assets totaled $18.8 billion and included no Company common stock. At December 31, 2012, plan assets totaled $17.7 billion and included no Company common stock. In 2013, the Company received $32 million from residual plan assets after the completion of a non-U.S. pension plan wind-up.

Investment Strategy and Risk Management for Plan Assets
The Company’s investment strategy for the plan assets is to manage the assets in relation to the liability in order to pay retirement benefits to plan participants over the life of the plans. This is accomplished by identifying and managing the exposure to various market risks, diversifying investments across various asset classes and earning an acceptable long-term rate of return consistent with an acceptable amount of risk, while considering the liquidity needs of the plans.

The plans are permitted to use derivative instruments for investment purposes, as well as for hedging the underlying asset and liability exposure and rebalancing the asset allocation. The plans use value at risk, stress testing, scenario analysis and Monte Carlo simulations to monitor and manage both the risk within the portfolios and the surplus risk of the plans.

Equity securities primarily include investments in large- and small-cap companies located in both developed and emerging markets around the world. Fixed income securities include investment and non-investment grade corporate bonds of companies diversified across industries, U.S. treasuries, non-U.S. developed market securities, U.S. agency mortgage-backed securities, emerging market securities and fixed income related funds. Alternative investments primarily include investments in real estate, private equity limited partnerships and absolute return strategies. Other significant investment types include various insurance contracts; and interest rate, equity, commodity and foreign exchange derivative investments and hedges. 

Strategic Weighted-Average Target Allocation of Plan
Assets for All Significant Plans
Asset Category
Target Allocation

Equity securities
39
%
Fixed Income securities
38
%
Alternative investments
22
%
Other investments
1
%
Total
100
%


Concentration of Risk
The Company mitigates the credit risk of investments by establishing guidelines with investment managers that limit investment in any single issue or issuer to an amount that is not material to the portfolio being managed. These guidelines are monitored for compliance both by the Company and external managers. Credit risk related to derivative activity is mitigated by utilizing multiple counterparties and through collateral support agreements.

The Northern Trust Collective Government Short Term Investment money market fund is utilized as the sweep vehicle for the U.S. plans, which from time to time can represent a significant investment. For one U.S. plan, approximately half of the liability is covered by a participating group annuity issued by Prudential Insurance Company.

The following tables summarize the bases used to measure the Company’s pension plan assets at fair value for the years ended December 31, 2013 and 2012:

Basis of Fair Value Measurements of
Pension Plan Assets at December 31, 2013
 
Quoted Prices
in Active
Markets for
Identical Items

 
Significant
Other
Observable
Inputs

 
Significant
Unobservable
Inputs

 
  
In millions
 
(Level 1)

 
(Level 2)

 
(Level 3)

 
Total

Cash and cash equivalents
 
$
83

 
$
1,179

 
$

 
$
1,262

Equity securities:
 
 
 
 
 
 
 
 
U.S. equity (1)
 
$
2,759

 
$
695

 
$

 
$
3,454

Non-U.S. equity – developed countries
 
2,014

 
1,122

 
2

 
3,138

Emerging markets
 
648

 
574

 
10

 
1,232

Convertible bonds
 
23

 
326

 

 
349

Equity derivatives
 
5

 
(27
)
 

 
(22
)
Total equity securities
 
$
5,449

 
$
2,690

 
$
12

 
$
8,151

Fixed income securities:
 
 
 
 
 
 
 
 
U.S. government and municipalities
 
$

 
$
1,154

 
$

 
$
1,154

U.S. agency and agency mortgage-backed securities
 

 
313

 

 
313

Corporate bonds – investment grade
 

 
1,397

 

 
1,397

Non-U.S. governments – developed countries
 

 
1,075

 

 
1,075

Non-U.S. corporate bonds – developed countries
 

 
838

 
2

 
840

Emerging market debt
 

 
106

 

 
106

Other asset-backed securities
 

 
113

 
15

 
128

High yield bonds
 

 
178

 
20

 
198

Other fixed income funds
 

 
243

 
200

 
443

Fixed income derivatives
 
(1
)
 
(31
)
 

 
(32
)
Total fixed income securities
 
$
(1
)
 
$
5,386

 
$
237

 
$
5,622

Alternative investments:
 
 
 
 
 
 
 
 
Real estate
 
$
30

 
$
33

 
$
1,338

 
$
1,401

Private equity
 

 

 
1,017

 
1,017

Absolute return
 

 
611

 
406

 
1,017

Total alternative investments
 
$
30

 
$
644

 
$
2,761

 
$
3,435

Other investments
 
$

 
$
317

 
$
40

 
$
357

Total pension plan assets at fair value
 
$
5,561

 
$
10,216

 
$
3,050

 
$
18,827


(1)    Includes no Company common stock.


Basis of Fair Value Measurements of
Pension Plan Assets at December 31, 2012
 
Quoted Prices
in Active
Markets for
Identical Items

 
Significant
Other
Observable
Inputs

 
Significant
Unobservable
Inputs

 
  
In millions
 
(Level 1)

 
(Level 2)

 
(Level 3)

 
Total

Cash and cash equivalents
 
$
20

 
$
599

 
$

 
$
619

Equity securities:
 
 
 
 
 
 
 
 
U.S. equity (1)
 
$
2,143

 
$
318

 
$

 
$
2,461

Non-U.S. equity – developed countries
 
1,989

 
1,203

 
4

 
3,196

Emerging markets
 
728

 
487

 
9

 
1,224

Convertible bonds
 

 
243

 

 
243

Equity derivatives
 
3

 
19

 

 
22

Total equity securities
 
$
4,863

 
$
2,270

 
$
13

 
$
7,146

Fixed income securities:
 
 
 
 
 
 
 
 
U.S. government and municipalities
 
$

 
$
1,464

 
$
2

 
$
1,466

U.S. agency and agency mortgage-backed securities
 

 
432

 

 
432

Corporate bonds – investment grade
 

 
1,626

 

 
1,626

Non-U.S. governments – developed countries
 

 
1,039

 
1

 
1,040

Non-U.S. corporate bonds – developed countries
 

 
802

 
1

 
803

Emerging market debt
 

 
72

 

 
72

Other asset-backed securities
 

 
122

 
15

 
137

High yield bonds
 

 
287

 
21

 
308

Other fixed income funds
 

 
228

 
218

 
446

Fixed income derivatives
 
1

 
119

 

 
120

Total fixed income securities
 
$
1

 
$
6,191

 
$
258

 
$
6,450

Alternative investments:
 
 
 
 
 
 
 
 
Real estate
 
$
32

 
$
30

 
$
1,224

 
$
1,286

Private equity
 

 

 
991

 
991

Absolute return
 

 
527

 
300

 
827

Total alternative investments
 
$
32

 
$
557

 
$
2,515

 
$
3,104

Other investments
 
$

 
$
364

 
$
42

 
$
406

Total pension plan assets at fair value
 
$
4,916

 
$
9,981

 
$
2,828

 
$
17,725

(1)    Includes no Company common stock.

For pension plan assets classified as Level 1 measurements (measured using quoted prices in active markets), total fair value is either the price of the most recent trade at the time of the market close or the official close price, as defined by the exchange on which the asset is most actively traded on the last trading day of the period, multiplied by the number of units held without consideration of transaction costs.

For pension or other postretirement benefit plan assets classified as Level 2 measurements, where the security is frequently traded in less active markets, fair value is based on the closing price at the end of the period; where the security is less frequently traded, fair value is based on the price a dealer would pay for the security or similar securities, adjusted for any terms specific to that asset or liability. Market inputs are obtained from well-established and recognized vendors of market data and subjected to tolerance/quality checks. For derivative assets and liabilities, standard industry models are used to calculate the fair value of the various financial instruments based on significant observable market inputs, such as foreign exchange rates, commodity prices, swap rates, interest rates and implied volatilities obtained from various market sources.

Some pension plan assets are held in funds where a net asset value is calculated based on the fair value of the underlying assets and the number of shares owned. The classification of the fund (Level 2 or 3 measurements) is determined based on the lowest level classification of significant holdings within the fund. For all other pension plan assets for which observable inputs are used, fair value is derived through the use of fair value models, such as a discounted cash flow model or other standard pricing models.

For pension plan assets classified as Level 3 measurements, total fair value is based on significant unobservable inputs including assumptions where there is little, if any, market activity for the investment. Investment managers or fund managers provide valuations of the investment on a monthly or quarterly basis. These valuations are reviewed for reasonableness based on applicable sector, benchmark and company performance. Adjustments to valuations are made where appropriate. Where available, audited financial statements are obtained and reviewed for the investments as support for the manager’s investment valuation.

The following table summarizes the changes in fair value of Level 3 pension plan assets for the years ended December 31, 2012 and 2013:

Fair Value Measurement of Level 3
Pension Plan Assets
 
Equity Securities

 
Fixed Income Securities

 
Alternative Investments

 
Other Investments

 
Total

In millions
Balance at January 1, 2012
 
$
16

 
$
100

 
$
2,328

 
$
42

 
$
2,486

Actual return on plan assets:
 
 
 
 
 
 
 
 
 
 
Relating to assets sold during 2012
 
(5
)
 
2

 
(59
)
 

 
(62
)
Relating to assets held at Dec 31, 2012
 
(3
)
 
19

 
193

 

 
209

Purchases, sales and settlements
 
7

 
141

 
(54
)
 

 
94

Transfers into (out of) Level 3, net
 
(2
)
 
(4
)
 
99

 

 
93

Foreign currency impact
 

 

 
8

 

 
8

Balance at December 31, 2012
 
$
13

 
$
258

 
$
2,515

 
$
42

 
$
2,828

Actual return on plan assets:
 
 
 
 
 
 
 
 
 
 
Relating to assets sold during 2013
 

 
42

 
176

 

 
218

Relating to assets held at Dec 31, 2013
 

 
(32
)
 
67

 
(1
)
 
34

Purchases, sales and settlements
 
2

 
(27
)
 
(5
)
 
(1
)
 
(31
)
Transfers (out of) Level 3, net
 
(3
)
 
(2
)
 

 

 
(5
)
Foreign currency impact
 

 
(2
)
 
8

 

 
6

Balance at December 31, 2013
 
$
12

 
$
237

 
$
2,761

 
$
40

 
$
3,050



The following table summarizes the bases used to measure the Company’s other postretirement benefit plan assets at fair value for the year ended December 31, 2012:

 
Basis of Fair Value Measurements of Other
Postretirement Benefit Plan Assets at
December 31, 2012
 
Quoted Prices
in Active
Markets for
Identical Items

 
Significant
Other
Observable
Inputs

 
  
 
 
In millions
 
(Level 1)

 
(Level 2)

 
Total

 
Cash and cash equivalents
 
$

 
$
7

 
$
7

 
Fixed income securities
 

 
58

 
58

 
Total assets at fair value
 
$

 
$
65

 
$
65


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