13. RETIREMENT BENEFITS

Plan Descriptions

U.S. 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 our policy 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 agreements. Company contributions for most plans are based on employer matching of employee contributions up to four percent of compensation for employees hired on or before April 1, 2016. In addition to the 401(k) defined contribution benefit, certain employees hired from July 1, 2008 through April 1, 2016, are eligible to participate in Retirement Account Contributions (RAC) in lieu of a defined benefit pension plan. Most employees hired after April 1, 2016 and certain employees that did not previously participate in the pension plan or receive RAC are eligible for an increased company match of up to seven percent of compensation. The company’s contributions to these defined contribution plans for the years ended December 31, 2017, 2016 and 2015, were $344 million, $311 million and $291 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 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 plans upon retirement from active service if they meet specified age and years of service requirements. Qualifying dependents are also eligible for plan benefits in certain circumstances. 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 health 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 subsidized post-retirement medical and life benefits.

The company provides subsidies to reimburse certain retirees for a portion of the cost of individual Medicare-supplemental coverage purchased directly by the retiree through a private insurance exchange.

Summary Plan Results

The cost to the company of its retirement benefit plans is shown in the following table:



	Year Ended December 31
	Pension Benefits									Medical and Life Benefits
$ in millions	2017			2016			2015			2017			2016			2015
Components of net periodic benefit cost
Service cost	$	424		$	446		$	484		$	23		$	30		$	35
Interest cost	1,234			1,284			1,224			84			94			94
Expected return on plan assets	(1,885		)	(1,853		)	(1,975		)	(89		)	(86		)	(89		)
Amortization of:
Prior service credit	(57		)	(60		)	(60		)	(22		)	(22		)	(28		)
Net loss from previous years	712			714			682			9			16			27
Other	4			—			—			1			—			—
Net periodic benefit cost	$	432		$	531		$	355		$	6		$	32		$	39

The table below summarizes the components of changes in unamortized benefit plan costs for the years ended December 31, 2015, 2016 and 2017:



$ in millions	Pension Benefits			Medical and Life Benefits			Total
Changes in unamortized benefit plan costs
Change in net actuarial loss	$	626		$	(125	)	$	501
Amortization of:
Prior service credit	60			28			88
Net loss from previous years	(682		)	(27		)	(709		)
Tax (benefit) expense related to above items	(1		)	46			45
Change in unamortized benefit plan costs – 2015	3			(78		)	(75		)
Change in net actuarial loss	1,003			(91		)	912
Amortization of:
Prior service credit	60			22			82
Net loss from previous years	(714		)	(16		)	(730		)
Tax (benefit) expense related to above items	(121		)	32			(89		)
Change in unamortized benefit plan costs – 2016	228			(53		)	175
Change in net actuarial loss	(476		)	(95		)	(571		)
Amortization of:
Prior service credit	57			22			79
Net loss from previous years	(712		)	(9		)	(721		)
Tax (benefit) expense related to above items	365			18			383
Change in unamortized benefit plan costs – 2017	$	(766	)	$	(64	)	$	(830	)

The table below presents the components of accumulated other comprehensive loss related to the company’s retirement benefit plans:



	Pension Benefits						Medical and Life Benefits
$ in millions	2017			2016			2017			2016
Amounts recorded in accumulated other comprehensive loss
Net actuarial loss	$	(7,842	)	$	(9,030	)	$	(9	)	$	(113	)
Prior service credit	187			244			22			44
Income tax benefits related to above items	3,042			3,407			14			32
Unamortized benefit plan costs	$	(4,613	)	$	(5,379	)	$	27		$	(37	)

The following table sets forth the funded status and amounts recognized in the consolidated statements of financial position for the company’s retirement benefit plans. Pension benefits data includes the qualified plans, foreign plans and U.S. unfunded non-qualified plans for benefits provided to directors, officers and certain employees. The company uses a December 31 measurement date for its plans.



	Pension Benefits						Medical and Life Benefits
$ in millions	2017			2016			2017			2016
Plan Assets
Fair value of plan assets at beginning of year	$	24,384		$	23,950		$	1,208		$	1,153
Net gain on plan assets	3,885			1,867			208			97
Employer contributions	596			81			45			83
Participant contributions	11			11			24			20
Benefits paid	(1,617		)	(1,480		)	(144		)	(146		)
Other	(33		)	(45		)	(3		)	1
Fair value of plan assets at end of year	27,226			24,384			1,338			1,208
Projected Benefit Obligation
Projected benefit obligation at beginning of year	30,409			29,182			2,100			2,181
Service cost	424			446			23			30
Interest cost	1,234			1,284			84			94
Participant contributions	11			11			24			20
Actuarial loss (gain)	1,526			1,026			26			(80		)
Benefits paid	(1,617		)	(1,480		)	(144		)	(146		)
Other	(20		)	(60		)	(3		)	1
Projected benefit obligation at end of year	31,967			30,409			2,110			2,100
Funded status	$	(4,741	)	$	(6,025	)	$	(772	)	$	(892	)

Classification of amounts recognized in the consolidated statements of financial position
Non-current assets	$	82		$	2		$	112		$	87
Current liability	(154		)	(146		)	(42		)	(42		)
Non-current liability	(4,669		)	(5,881		)	(842		)	(937		)

The following table shows those amounts expected to be recognized in net periodic benefit cost in 2018:



$ in millions	Pension Benefits			Medical and Life Benefits			Total
Amounts expected to be recognized in 2018 net periodic benefit cost
Net actuarial loss	$	535		$	—		$	535
Prior service credit	(58		)	(21		)	(79		)

The accumulated benefit obligation for all defined benefit pension plans was $31.6 billion and $30.1 billion at December 31, 2017 and 2016, respectively.

Amounts for pension plans with accumulated benefit obligations in excess of fair value of plan assets are as follows:



	December 31
$ in millions	2017		2016
Projected benefit obligation	$	29,804	$	30,350
Accumulated benefit obligation	29,454		30,065
Fair value of plan assets	24,981		24,322

Plan Assumptions

On a weighted-average basis, the following assumptions were used to determine benefit obligations and net periodic benefit cost:



	Pension Benefits				Medical and Life Benefits
	2017		2016		2017		2016
Assumptions used to determine benefit obligation at December 31
Discount rate	3.68	%	4.19	%	3.66	%	4.13	%
Initial cash balance crediting rate assumed for the next year	2.75	%	3.10	%
Rate to which the cash balance crediting rate is assumed to increase (the ultimate rate)	3.00	%	3.60	%
Year that the cash balance crediting rate reaches the ultimate rate	2023		2022
Rate of compensation increase	3.00	%	3.00	%
Initial health care cost trend rate assumed for the next year					6.50	%	6.50	%
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					2023		2020
Assumptions used to determine benefit cost for the year ended December 31
Discount rate	4.19	%	4.53	%	4.13	%	4.47	%
Initial cash balance crediting rate assumed for the next year	3.10	%	3.00	%
Rate to which the cash balance crediting rate is assumed to increase (the ultimate rate)	3.60	%	3.75	%
Year that the cash balance crediting rate reaches the ultimate rate	2022		2021
Expected long-term return on plan assets	8.00	%	8.00	%	7.70	%	7.70	%
Rate of compensation increase	3.00	%	3.00	%
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					2020		2020

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. Through consultation with our investment management team and outside investment advisers, management develops expected long-term returns for each of the plans’ strategic asset classes. In addition to our historical investment performance, we consider several factors, 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, we calculate a weighted-average expected long-term rate of return. 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 the Employee Retirement Income Security Act (ERISA). 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, 2017:



		Asset Allocation Ranges
Cash and cash equivalents		0% - 12%
U.S. equities		15% - 35%
International equities		10% - 30%
Fixed-income securities		20% - 55%
Alternative investments		8% - 28%

The table below provides the fair values of the company’s pension and Voluntary Employee Beneficiary Association (VEBA) trust plan assets at December 31, 2017 and 2016, 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 the definitions of these levels. Certain investments that are measured at fair value using net asset value (NAV) per share (or its equivalent) as a practical expedient are not required to be categorized in the fair value hierarchy table. The total fair value of these investments is included in the table below to permit reconciliation of the fair value hierarchy to amounts presented in the funded status table above. As of December 31, 2017 and 2016, there were no investments expected to be sold at a value materially different than NAV.



	Level 1					Level 2				Level 3				Total
$ in millions	2017		2016			2017		2016		2017		2016		2017		2016
Asset category
Cash and cash equivalents	$	55	$	72		$	4,086	$	2,477					$	4,141	$	2,549
U.S. equities	3,365		3,686							$	1	$	3	3,366		3,689
International equities	2,453		2,392			—		48		1		1		2,454		2,441
Fixed-income securities
U.S. Treasuries						1,282		1,109						1,282		1,109
U.S. Government Agency						345		424						345		424
Corporate bond						2		—						2		—
Non-U.S. Government						135		108						135		108
Corporate debt						4,404		3,723						4,404		3,723
Asset backed						255		296		—		1		255		297
High yield debt						866		1,844						866		1,844
Bank loans						248		297						248		297
Other Assets	15		(10		)	3		12		2		—		20		2
Investments valued using NAV as a practical expedient
U.S. equities														1,053		700
International equities														4,315		3,329
Fixed-income funds														129		99
Hedge funds														166		220
Opportunistic investments														873		581
Private equities														2,091		1,801
Real estate funds														2,419		2,379
Fair value of plan assets at the end of the year	$	5,888	$	6,140		$	11,626	$	10,338	$	4	$	5	$	28,564	$	25,592

There were no transfers of plan assets between the three levels of the fair value hierarchy during the years ended December 31, 2017 and 2016.

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. Cash and cash equivalents are predominantly held in money market or short-term investment funds. U.S. and international equities consist primarily of common stocks and institutional common trust funds. Investments in certain equity securities, which include domestic and international securities and registered investment companies, are valued at the last reported sales or quoted price on the last business day of the reporting period. Fair values for certain fixed-income securities, which are not exchange-traded, are valued using third-party pricing services.

Other assets include derivative assets with a fair value of $34 million and $19 million, derivative liabilities with a fair value of $19 million and $28 million, and net notional amounts of $3.3 billion and $2.0 billion, as of December 31, 2017 and 2016, respectively. Derivative instruments may include exchange traded futures contracts, interest rate swaps, options on futures and swaps, currency contracts, total return swaps and credit default swaps. Notional amounts do not quantify risk or represent assets or liabilities of the pension and VEBA trusts, but are used in the calculation of cash settlement under the contracts. The volume of derivative activity is commensurate with the amounts disclosed at year-end. Certain derivative financial instruments within the pension trust are subject to master netting agreements with certain counterparties.

Investments in certain equity and fixed-income funds, which include common/collective trust funds, and alternative investments, including hedge funds, opportunistic investments, private equity funds and real estate funds, are valued based on the NAV derived by the investment managers, as a practical expedient, and are described further below.

U.S. and International equities: Generally, redemption periods are monthly with a notice requirement less than 30 days. As of December 31, 2017 and 2016, unfunded commitments were not material.

Fixed-income funds: Redemption periods are daily, monthly or quarterly with various notice requirements but generally are less than 30 days. As of December 31, 2017 and 2016, there were no unfunded commitments.

Hedge funds: The redemption period of hedge funds is generally quarterly and requires a 90-day notice. As of December 31, 2017 and 2016, there were no unfunded commitments.

Opportunistic investments: Opportunistic investments are primarily held in partnerships with a 5-10 year life. As of December 31, 2017 and 2016, unfunded commitments were $768 million and $638 million, respectively.

Private equities: The term of each fund is typically 10 or more years and the fund’s investors do not have an option to redeem their interest in the fund. As of December 31, 2017 and 2016, unfunded commitments were $1.4 billion and $1.3 billion, respectively.

Real estate funds: Consists of closed-end real estate funds and infrastructure funds with terms that are typically 10 or more years. This class also contains open-end funds that generally allow investors to redeem their interests in the fund. As of December 31, 2017 and 2016, unfunded commitments were $71 million and $72 million, respectively.

For the years ended December 31, 2017 and 2016, 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, 2017:



$ in millions	Pension Plans		Medical and Life Plans		Total
Year Ending December 31
2018	$	1,573	$	149	$	1,722
2019	1,618		153		1,771
2020	1,665		144		1,809
2021	1,713		144		1,857
2022	1,757		143		1,900
2023 through 2027	9,410		676		10,086

In 2018, the company expects to contribute the required minimum funding of approximately $87 million to its pension plans and approximately $43 million to its medical and life benefit plans. During the year ended December 31, 2017, the company made a voluntary pension contribution of $500 million.