NOTE 5. COMPANY-SPONSORED EMPLOYEE BENEFIT PLANS

We sponsor various retirement and pension plans, including defined benefit and defined contribution plans which cover our employees worldwide.

U.S. Pension Benefits

In the U.S. we maintain the following single-employer defined benefit pension plans: UPS Retirement Plan, UPS Pension Plan, UPS IBT Pension Plan and the UPS Excess Coordinating Benefit Plan, a non-qualified plan.

The UPS Retirement Plan is noncontributory and includes substantially all eligible employees of participating domestic subsidiaries who are not members of a collective bargaining unit, as well as certain employees covered by a collective bargaining agreement. This plan generally provides for retirement benefits based on average compensation levels earned by employees prior to retirement. Benefits payable under this plan are subject to maximum compensation limits and the annual benefit limits for a tax qualified defined benefit plan as prescribed by the Internal Revenue Service (“IRS”).

The UPS Excess Coordinating Benefit Plan is a non-qualified plan that provides benefits to certain participants in the UPS Retirement Plan for amounts that exceed the benefit limits described above.

The UPS Pension Plan is noncontributory and includes certain eligible employees of participating domestic subsidiaries and members of collective bargaining units that elect to participate in the plan. This plan generally provides for retirement benefits based on service credits earned by employees prior to retirement.

The UPS IBT Pension Plan is noncontributory and includes employees that were previously members of the Central States, Southeast and Southwest Areas Pension Fund (“Central States Pension Fund”), a multiemployer pension plan, in addition to other eligible employees who are covered under certain collective bargaining agreements.

 

U.S. Postretirement Medical Benefits

We also sponsor postretirement medical plans in the U.S. that provide health care benefits to our retirees who meet certain eligibility requirements and who are not otherwise covered by multiemployer plans. Generally, this includes employees with at least 10 years of service who have reached age 55 and employees who are eligible for postretirement medical benefits from a Company-sponsored plan pursuant to collective bargaining agreements. We have the right to modify or terminate certain of these plans. These benefits have been provided to certain retirees on a noncontributory basis; however, in many cases, retirees are required to contribute all or a portion of the total cost of the coverage.

International Pension Benefits

We also sponsor various defined benefit plans covering certain of our international employees. The majority of our international obligations are for defined benefit plans in Canada and the United Kingdom. In addition, many of our international employees are covered by government-sponsored retirement and pension plans. We are not directly responsible for providing benefits to participants of government-sponsored plans.

Defined Contribution Plans

We also sponsor several defined contribution plans for all employees not covered under collective bargaining agreements, and for certain employees covered under collective bargaining agreements. The Company matches, in shares of UPS common stock or cash, a portion of the participating employees’ contributions. In early 2009, we suspended the company matching contributions to the primary employee defined contribution plan. A revised program of company matching contributions was reinstated effective January 1, 2011. Matching contributions charged to expense were $80, $4 and $21 million for 2011, 2010 and 2009, respectively.

Contributions are also made to defined contribution money purchase plans under certain collective bargaining agreements. Amounts charged to expense were $76, $78 and $80 million for 2011, 2010, and 2009, respectively.

Net Periodic Benefit Cost

Information about net periodic benefit cost for the company-sponsored pension and postretirement benefit plans is as follows (in millions):

 

		U.S. Pension Benefits												U.S. Postretirement Medical Benefits												International Pension Benefits
		2011				2010				2009				2011				2010				2009				2011				2010				2009
Net Periodic Cost:
Service cost		$	870			$	723			$	689			$	89			$	86			$	85			$	34			$	24			$	17
Interest cost			1,309				1,199				1,130				207				214				211				39				34				28
Expected return on assets			(1,835	)			(1,381	)			(1,151	)			(16	)			(22	)			(27	)			(43	)			(36	)			(26	)
Amortization of:
Transition obligation			—				—				4				—				—				—				—				—				—
Prior service cost			171				172				178				7				4				6				1				1				1
Actuarial (gain) loss			736				70				—				—				—				—				91				42				16
Other			—				—				3				—				—				—				—				6				1
Net periodic benefit cost		$	1,251			$	783			$	853			$	287			$	282			$	275			$	122			$	71			$	37

 

Actuarial Assumptions

The table below provides the weighted-average actuarial assumptions used to determine the net periodic benefit cost.

 

		U.S. Pension Benefits												U.S. Postretirement Medical Benefits												International Pension Benefits
		2011				2010				2009				2011				2010				2009				2011				2010				2009
Discount rate			5.98	%			6.58	%			6.75	%			5.77	%			6.43	%			6.66	%			5.36	%			5.84	%			6.17	%
Rate of compensation increase			4.50	%			4.50	%			4.50	%			N/A				N/A				N/A				3.57	%			3.62	%			3.65	%
Expected return on assets			8.75	%			8.75	%			8.96	%			8.75	%			8.75	%			9.00	%			7.31	%			7.25	%			7.09	%

The table below provides the weighted-average actuarial assumptions used to determine the benefit obligations of our plans.

 

		U.S. Pension Benefits								U.S. Postretirement Medical Benefits								International Pension Benefits
		2011				2010				2011				2010				2011				2010
Discount rate			5.64	%			5.98	%			5.47	%			5.77	%			4.63	%			5.36	%
Rate of compensation increase			4.50	%			4.50	%			N/A				N/A				3.58	%			3.57	%

A discount rate is used to determine the present value of our future benefit obligations. To determine our discount rate for our U.S. pension and other postretirement benefit plans, we use a bond matching approach to select specific bonds that would satisfy our projected benefit payments. We believe the bond matching approach reflects the process we would employ to settle our pension and postretirement benefit obligations. For our international plans, the discount rate is determined by matching the expected cash flows of a sample plan of similar duration to a yield curve based on long-term, high quality fixed income debt instruments available as of the measurement date. For 2011, each basis point increase in the discount rate decreases the projected benefit obligation by approximately $39 million and $4 million for pension and postretirement medical benefits, respectively. These assumptions are updated each measurement date, which is typically annually.

An assumption for expected return on plan assets is used to determine a component of net periodic benefit cost for the fiscal year. This assumption for our U.S. plans was developed using a long-term projection of returns for each asset class, and taking into consideration our target asset allocation. The expected return for each asset class is a function of passive, long-term capital market assumptions and excess returns generated from active management. The capital market assumptions used are provided by independent investment advisors, while excess return assumptions are supported by historical performance, fund mandates and investment expectations. In addition, we compare the expected return on asset assumption with the average historical rate of return these plans have been able to generate.

For plans outside the U.S., consideration is given to local market expectations of long-term returns. Strategic asset allocations are determined by country, based on the nature of liabilities and considering the demographic composition of the plan participants.

Health care cost trends are used to project future postretirement benefits payable from our plans. For year-end 2011 U.S. plan obligations, future postretirement medical benefit costs were forecasted assuming an initial annual increase of 8.0%, decreasing to 5.0% by the year 2018 and with consistent annual increases at those ultimate levels thereafter.

 

Assumed health care cost trends can have a significant effect on the amounts reported for the U.S. postretirement medical plans. A one-percent change in assumed health care cost trend rates would have had the following effects on 2011 results (in millions):

 

		1% Increase				1% Decrease
Effect on total of service cost and interest cost		$	6			$	(6	)
Effect on postretirement benefit obligation		$	61			$	(65	)

Benefit Obligations and Fair Value of Plan Assets

The following table provides a reconciliation of the changes in the plans’ benefit obligations and fair value of plan assets as of the respective measurement dates in each year (in millions).

 

		U.S. Pension Benefits								U.S. Postretirement Medical Benefits								International Pension Benefits
		2011				2010				2011				2010				2011				2010
Benefit Obligations:
Projected benefit obligation at beginning of year		$	21,342			$	17,763			$	3,597			$	3,336			$	680			$	575
Service cost			870				723				89				86				34				24
Interest cost			1,309				1,199				207				214				39				34
Gross benefits paid			(657	)			(574	)			(219	)			(207	)			(15	)			(13	)
Plan participants’ contributions			—				—				16				17				1				1
Plan amendments			3				(7	)			(24	)			8				7				—
Actuarial (gain)/loss			1,519				2,238				170				142				99				58
Foreign currency exchange rate changes			—				—				—				—				(4	)			(4	)
Curtailments and settlements			—				—				—				—				—				(1	)
Other			—				—				—				1				—				6
Projected benefit obligation at end of year		$	24,386			$	21,342			$	3,836			$	3,597			$	841			$	680
		U.S. Pension Benefits								U.S. Postretirement Medical Benefits								International Pension Benefits
		2011				2010				2011				2010				2011				2010
Fair Value of Plan Assets:
Fair value of plan assets at beginning of year		$	20,092			$	15,351			$	233			$	298			$	561			$	481
Actual return on plan assets			1,956				2,215				9				30				10				48
Employer contributions			1,272				3,100				108				95				56				45
Plan participants’ contributions			—				—				16				17				1				1
Gross benefits paid			(657	)			(574	)			(219	)			(207	)			(15	)			(13	)
Foreign currency exchange rate changes			—				—				—				—				—				—
Curtailments and settlements			—				—				—				—				—				(1	)
Other			—				—				27				—				—				—
Fair value of plan assets at end of year		$	22,663			$	20,092			$	174			$	233			$	613			$	561

 

Funded Status

The following table discloses the funded status of our plans and the amounts recognized in our balance sheet as of December 31 (in millions):

 

		U.S. Pension Benefits								U.S. Postretirement Medical Benefits								International Pension Benefits
		2011				2010				2011				2010				2011				2010
Funded Status:
Fair value of plan assets		$	22,663			$	20,092			$	174			$	233			$	613			$	561
Benefit obligation			(24,386	)			(21,342	)			(3,836	)			(3,597	)			(841	)			(680	)
Funded status recognized at December 31		$	(1,723	)		$	(1,250	)		$	(3,662	)		$	(3,364	)		$	(228	)		$	(119	)
Funded Status Amounts Recognized in our Balance Sheet:
Other non-current assets		$	—			$	42			$	—			$	—			$	1			$	1
Other current liabilities			(13	)			(11	)			(93	)			(99	)			(3	)			(3	)
Pension and postretirement benefit obligations			(1,710	)			(1,281	)			(3,569	)			(3,265	)			(226	)			(117	)
Net liability at December 31		$	(1,723	)		$	(1,250	)		$	(3,662	)		$	(3,364	)		$	(228	)		$	(119	)
Amounts Recognized in AOCI:
Unrecognized net prior service cost		$	(1,492	)		$	(1,660	)		$	(82	)		$	(113	)		$	(14	)		$	(8	)
Unrecognized net actuarial loss			(2,439	)			(1,777	)			(307	)			(157	)			(52	)			(22	)
Gross unrecognized cost at December 31			(3,931	)			(3,437	)			(389	)			(270	)			(66	)			(30	)
Deferred tax asset at December 31			1,479				1,292				146				102				16				3
Net unrecognized cost at December 31		$	(2,452	)		$	(2,145	)		$	(243	)		$	(168	)		$	(50	)		$	(27	)

The accumulated benefit obligation for our pension plans as of the measurement dates in 2011 and 2010 was $23.307 and $20.241 billion, respectively.

Benefit payments under the pension plans include $14 million paid from employer assets in both 2011 and 2010. Benefit payments (net of participant contributions) under the postretirement medical benefit plans include $108 and $94 million paid from employer assets in 2011 and 2010, respectively. Such benefit payments from employer assets are also categorized as employer contributions.

At December 31, 2011 and 2010, the projected benefit obligation, the accumulated benefit obligation, and the fair value of plan assets for pension plans with benefit obligations in excess of plan assets were as follows (in millions):

 

		Projected Benefit Obligation Exceeds the Fair Value of  Plan Assets								Accumulated Benefit Obligation Exceeds the Fair Value of  Plan Assets
		2011				2010				2011				2010
U.S. Pension Benefits
Projected benefit obligation		$	24,386			$	3,227			$	7,499			$	3,227
Accumulated benefit obligation			22,574				3,195				7,395				3,195
Fair value of plan assets			22,663				1,934				6,646				1,934
International Pension Benefits
Projected benefit obligation		$	814			$	662			$	499			$	362
Accumulated benefit obligation			714				323				448				323
Fair value of plan assets			594				543				296				257

 

The increase in U.S. pension benefits amounts where the projected benefit obligation exceeds the fair value of plan assets is due to the funded status for both the UPS Retirement Plan and UPS Pension Plan changing from overfunded at December 31, 2010 to underfunded at December 31, 2011.

The accumulated postretirement benefit obligation exceeds plan assets for all of our U.S. postretirement medical benefit plans.

Accumulated Other Comprehensive Income

The estimated amounts of prior service cost in AOCI expected to be amortized and recognized as a component of net periodic benefit cost in 2012 are as follows (in millions):

 

		U.S. Pension Benefits				U.S. Postretirement Medical Benefits				International Pension Benefits
Prior service cost / (benefit)		$	173			$	5			$	2

Pension and Postretirement Plan Assets

The applicable benefit plan committees establish investment guidelines and strategies, and regularly monitor the performance of the funds and portfolio managers. Our investment guidelines address the following items: governance, general investment beliefs and principles, investment objectives, specific investment goals, process for determining/maintaining the asset allocation policy, long-term asset allocation, rebalancing, investment restrictions/prohibited transactions, portfolio manager structure and diversification (which addresses limits on the amount of investments held by any one manager to minimize risk), portfolio manager selection criteria, plan evaluation, portfolio manager performance review and evaluation and risk management (including various measures used to evaluate risk tolerance).

Our investment strategy with respect to pension assets is to invest the assets in accordance with applicable laws and regulations. The long-term primary objectives for our pension assets are to: (1) provide for a reasonable amount of long-term growth of capital, with prudent exposure to risk; and protect the assets from erosion of purchasing power; (2) provide investment results that meet or exceed the plans’ expected long-term rate of return; and (3) match the duration of the liabilities and assets of the plans to reduce the potential risk of large employer contributions being necessary in the future. The plans strive to meet these objectives by employing portfolio managers to actively manage assets within the guidelines and strategies set forth by the benefit plan committees. These managers are evaluated by comparing their performance to applicable benchmarks.

 

The fair values of U.S. pension and postretirement benefit plan assets by asset category as of December 31, 2011 are presented below (in millions), as well as the percentage that each category comprises of our total plan assets and the respective target allocations.

 

		Level 1				Level 2				Level 3				Total Assets				Percentage of Plan Assets - 2011				Target Allocation 2011
Asset Category:
Cash and cash equivalents		$	74			$	1			$	—			$	75				0.3	%			0-5	%
Equity Securities:
U.S. Large Cap			2,264				2,460				—				4,724
U.S. Small Cap			706				27				—				733
Global Equity			1,115				12				—				1,127
International Core			592				926				—				1,518
Emerging Markets			389				264				—				653
International Small Cap			362				165				—				527
Total Equity Securities			5,428				3,854				—				9,282				40.7				40-60
Fixed Income Securities:
U.S. Government Securities			3,412				1,217				—				4,629
Corporate Bonds			9				3,462				80				3,551
Municipal Bonds			—				104				—				104
Total Fixed Income Securities			3,421				4,783				80				8,284				36.3				20-40
Other Investments:
Hedge Funds			—				—				2,743				2,743				12.0				5-15
Real Estate			151				—				948				1,099				4.8				1-10
Private Equity			—				—				1,354				1,354				5.9				1-10
Total U.S. Plan Assets		$	9,074			$	8,638			$	5,125			$	22,837				100.0	%

 

The fair values of U.S. pension and postretirement benefit plan assets by asset category as of December 31, 2010 are presented below (in millions), as well as the percentage that each category comprises of our total plan assets and the respective target allocations.

 

		Level 1				Level 2				Level 3				Total Assets				Percentage of Plan Assets - 2010				Target Allocation 2010
Asset Category:
Cash and cash equivalents		$	—			$	579			$	—			$	579				2.9	%			0-5	%
Equity Securities:
U.S. Large Cap			4,897				—				—				4,897
U.S. Small Cap			874				—				—				874
International Core			1,219				920				—				2,139
Emerging Markets			528				281				—				809
International Small Cap			117				196				—				313
Total Equity Securities			7,635				1,397				—				9,032				44.4				40-60
Fixed Income Securities:
U.S. Government Securities			3,502				313				—				3,815
Corporate Bonds			608				1,694				193				2,495
Mortgage-Backed Securities			—				50				—				50
Total Fixed Income Securities			4,110				2,057				193				6,360				31.3				20-40
Other Investments:
Hedge Funds			—				—				2,023				2,023				10.0				5-15
Real Estate			98				135				789				1,022				5.0				1-10
Private Equity			—				—				1,309				1,309				6.4				1-10
Total U.S. Plan Assets		$	11,843			$	4,168			$	4,314			$	20,325				100.0	%

There were no UPS class A or B shares of common stock directly held in plan assets as of December 31, 2011. Equity securities include UPS class A shares of common stock in the amount of $346 million (1.7% of total plan assets) as of December 31, 2010.

Pension assets utilizing Level 1 inputs include fair values of equity investments, corporate debt instruments, and U.S. government securities that were determined by closing prices for those securities traded on national stock exchanges, while securities traded in the over-the-counter market and listed securities for which no sale was reported on the valuation date are valued at the mean between the last reported bid and asked prices.

Level 2 assets include certain bonds that are valued based on yields currently available on comparable securities of other issues with similar credit ratings, mortgage-backed securities that are valued based on cash flow and yield models using acceptable modeling and pricing conventions, and certain investments that are pooled with other investments held by the trustee in a commingled employee benefit trust fund. The investments in the commingled funds are valued by taking the percentage owned by the respective plan in the underlying net asset value of the trust fund, which was determined in accordance with the paragraph above.

Certain investments’ estimated fair value is based on unobservable inputs that are not corroborated by observable market data and are thus classified as Level 3. These investments include commingled funds comprised of corporate and government bonds, hedge funds, real estate investments and private equity funds. The commingled funds are valued using net asset values, adjusted, as appropriate, for investment fund specific inputs determined to be significant to the valuation. Investments in hedge funds are valued using reported net asset values as of December 31. These assets are primarily invested in a portfolio of diversified, direct investments and funds of hedge funds. Real estate investments and private equity funds are valued using fair values per the most recent partnership audited financial reports, adjusted as appropriate for any lag between the date of the financial reports and December 31. The real estate investments consist of U.S. and non-U.S. real estate investments and are broadly diversified. The fair values may, due to the inherent uncertainty of valuation for those alternative investments, differ significantly from the values that would have been used had a ready market for the alternative investments existed, and the differences could be material.

At December 31, 2011 and 2010, $3.895 and $3.766 billion of plan assets are held in commingled stock funds that hold U.S. and international public market securities. The plans held the right to liquidate positions in these commingled stock funds at any time, subject only to a brief notification period. No unfunded commitments existed with respect to these commingled stock funds at December 31, 2011.

The plans hold $2.302 and $2.098 billion of investments in limited partnership interests in various private equity and real estate funds. Limited provision exists for the redemption of these interests by the general partners that invest in these funds until the end of the term of the partnerships, typically ranging between 12 and 18 years from the date of inception. An active secondary market exists for similar partnership interests, although no particular value (discount or premium) can be guaranteed. At December 31, 2011, unfunded commitments to such limited partnerships totaling approximately $701 million are expected to be contributed over the remaining investment period, typically ranging between three and six years.

At December 31, 2011 and 2010, $2.743 and $2.023 billion of plan investments are held in hedge funds that pursue multiple strategies to diversify risk and reduce volatility. Most of these funds allow redemptions either quarterly or semi-annually after a two to three month notice period, while other funds allow for redemption after only a brief notification period with no restriction on redemption frequency. No unfunded commitments existed with respect to these hedge funds as of December 31, 2011.

The following tables presents the changes in the Level 3 instruments measured on a recurring basis for the years ended December 31, 2011 and 2010 (in millions):

 

		Corporate Bonds				Hedge Funds				Real Estate				Private Equity				Total
Balance on January 1, 2010		$	201			$	1,284			$	550			$	1,145			$	3,180
Actual Return on Assets:
Assets Held at End of Year			(5	)			129				100				177				401
Assets Sold During the Year			13				10				—				1				24
Purchases			41				711				152				149				1,053
Sales			(57	)			(111	)			(13	)			(163	)			(344	)
Settlements			—				—				—				—				—
Transfers Into (Out of) Level 3			—				—				—				—				—
Balance on December 31, 2010		$	193			$	2,023			$	789			$	1,309			$	4,314
Actual Return on Assets:
Assets Held at End of Year			(14	)			122				144				145				397
Assets Sold During the Year			3				22				5				—				30
Purchases			57				757				150				164				1,128
Sales			(159	)			(181	)			(140	)			(264	)			(744	)
Settlements			—				—				—				—				—
Transfers Into (Out of) Level 3			—				—				—				—				—
Balance on December 31, 2011		$	80			$	2,743			$	948			$	1,354			$	5,125

 

The fair value disclosures above have not been provided for our international pension benefit plans since asset allocations are determined and managed at the individual country level. In general, the asset allocations for these plans are approximately 55% in equity securities, 35% in debt securities and 10% in other securities. The amount of assets having significant unobservable inputs (Level 3), if any, in these plans would be immaterial to our financial statements.

Expected Cash Flows

Information about expected cash flows for the pension and postretirement benefit plans is as follows (in millions):

 

		U.S. Pension Benefits				U.S. Postretirement Medical Benefits				International Pension Benefits
Employer Contributions:
2012 (expected) to plan trusts		$	355			$	371			$	53
2012 (expected) to plan participants			13				101				3
Expected Benefit Payments:
2012		$	708			$	233			$	18
2013			789				253				17
2014			873				230				19
2015			966				246				21
2016			1,065				260				23
2017 - 2021			7,112				1,466				153

Our funding policy for U.S. plans is to contribute amounts annually that are at least equal to the amounts required by applicable laws and regulations, or to directly fund payments to plan participants, as applicable. International plans will be funded in accordance with local regulations. Additional discretionary contributions may be made when deemed appropriate to meet the long-term obligations of the plans. Expected benefit payments for pensions will be primarily paid from plan trusts. Expected benefit payments for postretirement medical benefits will be paid from plan trusts and corporate assets.