16. Retirement Plans

Lorillard has defined benefit pension, postretirement benefits, profit sharing and savings plans for eligible employees.

Pension and postretirement benefits—The Salaried Pension Plan provides benefits based on employees’ compensation and service. The Hourly Pension Plan provides benefits based on fixed amounts for each year of service. Lorillard also provides medical and life insurance benefits to eligible employees. Lorillard uses a December 31 measurement date for its plans.

Lorillard also provides certain senior level management employees with nonqualified, unfunded supplemental retirement plans. While these plans are unfunded, Lorillard has certain assets invested in an executive life insurance policy that are to be used to provide for certain of these benefits.

Weighted-average assumptions used to determine benefit obligations:


	Pension Benefits		Other Postretirement Benefits
	December 31,		December 31,
	2013	2012	2013	2012
Discount rate	4.70%-4.90%	3.90%-4.25%	4.60%-4.70%	3.90%-4.00%
Rate of compensation increase	4.25%	4.25%

Weighted-average assumptions used to determine net periodic benefit cost:


	Pension Benefits			Other Postretirement Benefits
	Year Ended December 31,			Year Ended December 31,
	2013	2012	2011	2013	2012	2011
Discount rate	3.90%-4.25%	4.70%-4.90%	5.40%-5.75%	3.90%-4.00%	4.60%-4.80%	5.25%-5.50%
Expected long-term return on plan assets	7.75%	7.75%	7.50%
Rate of compensation increase	4.25%	4.75%	4.75%

The expected long-term rate of return for Plan assets is determined based on widely-accepted capital market principles, long-term return analysis for global fixed income and equity markets and the active total return oriented portfolio management style. The methodology used to derive asset class risk/return estimates varies due to the nature of asset classes, the availability of historical data, implications from currency, and other factors. In many cases, where historical data is available, data is drawn from indices such as Morgan Stanley Capital International (“MSCI”) or G7 country data. For alternative asset classes where historical data may be insufficient or incomplete, estimates are based on long-term capital market conditions and/or asset class relationships. The expected rate of return for the Plan is based on the target asset allocation and return assumptions for each asset class. The estimated Plan return represents a nominal compound return which captures the effect of estimated asset class and market volatility.

Assumed health care cost trend rates for other postretirement benefits:


	Other Postretirement Benefits
	Year Ended December 31,
	2013			2012
Pre-65 health care cost trend rate assumed for next year		8.0	%		8.5	%
Post-65 health care cost trend rate assumed for next year		6.0	%		6.0	%
Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)		4.5	%		4.5	%
Year that the rate reaches the ultimate trend rate:
Pre-65		2021			2021
Post-65		2021			2021

Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:


	One Percentage Point
	Increase		Decrease
	(In millions)
Effect on postretirement benefit obligations	$	15	$	12
Effect on total of service and interest cost		2		1

Net periodic pension and other postretirement benefit costs include the following components:


	Pension Benefits									Other Postretirement Benefits
	Year Ended December 31,									Year Ended December 31,
	2013			2012			2011			2013		2012			2011
	(In millions)
Service cost	$	26		$	24		$	18		$	6	$	5		$	4
Interest cost		51			55			56			9		10			10
Expected return on plan assets		(82	)		(76	)		(73	)		—		—			—
Amortization of unrecognized net loss (gain)		21			22			8			1		—			—
Amortization of unrecognized prior service cost		4			4			4			—		(1	)		(1	)

Net periodic benefit cost	$	20		$	29		$	13		$	16	$	14		$	13

The following provides a reconciliation of benefit obligations, plan assets and funded status of the pension and postretirement plans.


	Pension Benefits						Other Postretirement Benefits
	December 31,						December 31,
	2013			2012			2013			2012
	(In millions)
Change in benefit obligation:
Benefit obligation at January 1	$	1,265		$	1,183		$	230		$	212
Service cost		26			24			6			5
Interest cost		51			55			9			10
Plan participants’ contributions		—			—			5			5
Amendments		—			—			—			2
Actuarial (gain) loss		(98	)		66			(19	)		12
Benefits paid		(65	)		(63	)		(18	)		(18	)
Other		—			—			—			2

Benefit obligation at December 31		1,179			1,265			213			230

Change in plan assets:
Fair value of plan assets at January 1		1,078			998			—			—
Actual return on plan assets		90			112			—			—
Employer contributions		31			31			13			13
Plan participants’ contributions		—			—			5			5
Benefits paid from plan assets		(65	)		(63	)		(18	)		(18	)

Fair value of plan assets at December 31		1,134			1,078			—			—

Funded status	$	(45	)	$	(187	)	$	(213	)	$	(230	)

Amounts recognized in the balance sheets consist of:
Noncurrent assets	$	55		$	—		$	—		$	—
Current liabilities		—			—			(14	)		(14	)
Noncurrent liabilities		(100	)		(187	)		(199	)		(216	)

Net amount recognized	$	(45	)	$	(187	)	$	(213	)	$	(230	)


Net actuarial (gain) loss	$	(107	)	$	30		$	(19	)	$	12
Recognized actuarial gain (loss)		(21	)		(22	)		(1	)		—
Prior service cost		—			—			—			2
Recognized prior service cost		(4	)		(4	)		—			—

Total recognized in other comprehensive (income) loss	$	(132	)	$	4		$	(20	)	$	14

Total recognized net periodic benefit cost and other comprehensive (income) loss	$	(112	)	$	33		$	(4	)	$	28

Information for pension plans with an accumulated benefit obligation in excess of plan assets consisted of the following:


	Pension Benefits
	December 31,
	2013		2012
	(In millions)
Projected benefit obligation	$	682	$	1,265
Accumulated benefit obligation		615		1,189
Fair value of plan assets		582		1,078

The table below presents the estimated amounts to be recognized from accumulated other comprehensive income into net periodic benefit cost during 2014.


	Pension Benefits		Other Postretirement Benefits
	(In millions)
Amortization of actuarial (gain) loss	$	9	$	(1	)
Amortization of prior service cost		3		—

Total estimated amounts to be recognized	$	12	$	(1	)

Lorillard projects expected future minimum benefit payments as follows.


Expected future benefit payments	Pension Benefits		Other Postretirement Benefit Plans		Less Medicare Drug Subsidy		Net
	(In millions)
2014	$	69	$	15	$	1	$	83
2015		71		16		1		86
2016		73		16		1		88
2017		74		16		1		89
2018		76		17		1		92
2019 – 2023		404		83		2		485

	$	767	$	163	$	7	$	923

Lorillard expects to contribute $1 million to its pension plans and $15 million to its other postretirement benefit plans in 2014.

The general principles guiding the investment of the Plan assets are embodied in the Employee Retirement Income Security Act of 1974 (ERISA). These principles include discharging Lorillard’s investment responsibilities for the exclusive benefit of Plan participants and in accordance with the “prudent expert” standards and other ERISA rules and regulations. Investment objectives for Lorillard’s pension Plan assets are to optimize the long-term return on Plan assets while maintaining an acceptable level of risk, to diversify assets among asset classes and investment styles, and to maintain a long-term focus.

The Plan is managed using a Liability Driven Investment (“LDI”) framework which focuses on achieving the Plan’s return goals while assuming a reasonable level of funded status volatility.

Based on this LDI framework the asset allocation has two primary components. The first component of the asset allocation is the “hedging portfolio” which uses the Plan’s fixed income portfolio to hedge a portion of the interest rate risk associated with the Plan’s liabilities, thereby reducing the Plan’s expected funded status volatility. The second component is the “growth/equity portfolio” which is designed to enhance portfolio returns. The growth portfolio is broadly diversified across the following asset classes; Global Equities, Long Short Equities, Absolute Return Hedge Funds, Private Equity (including growth equity, buyouts, and other illiquid assets designed to enhance returns), and Private Real Assets. Alternative investments, including hedge funds, are used judiciously to enhance risk adjusted long-term returns while improving portfolio diversification. Overlay derivatives are used to assist in the rebalancing of the total portfolio to the strategic asset allocation. Derivatives may be used to gain market exposure in an efficient and timely manner. Investment risk is measured and monitored on an ongoing basis through annual liability measurements, periodic asset/liability studies, and quarterly investment portfolio reviews.

The pension plans asset allocations were:


	Asset Allocation as of 12/31/13		Asset Allocation as of 12/31/12
	(%)		(%)
Asset Class
U.S. Equity		9.4		10.6
Global ex U.S. Equity		9.6		8.0
Global ex Emerging Markets Equity		4.7		3.8
Emerging Markets Equity		3.9		3.7
Absolute Return Hedge Funds		16.6		13.9
Equity Hedge Funds		13.6		11.4
Private Equity		4.5		4.7
Private Real Assets		2.9		2.2
Public Real Assets		2.0		2.3
Fixed Income		29.5		37.3
Cash Equivalents		3.3		2.1

Total		100.0		100.0

Fair Value Measurements—The fair value hierarchy has three levels based on the observability of the inputs used to determine fair value. Level 1 refers to fair values determined based on quoted prices in active markets for identical assets. Level 2 refers to fair values estimated using significant other observable inputs. Level 3 includes fair values estimated using significant non-observable inputs. Plan assets using the fair value hierarchy as of December 31, 2013 were as follows:


	Total			Level 1		Level 2			Level 3
	(In millions)
Asset Class:
U.S. Equity:
Securities	$	111		$	15	$	—		$	96
Overlay derivatives liabilities		(5	)		—		(5	)		—
Global ex U.S. Equity		109			—		109			—
Global ex Emerging Markets Equity		53			—		31			22
Emerging Markets Equity:
Securities		28			—		28			—
Overlay derivatives assets		17			—		17			—
Absolute Return Hedge Funds		188			—		58			130
Equity Hedge Funds		155			—		74			81
Private Equity		51			—		—			51
Private Real Assets		33			—		—			33
Public Real Assets		22			—		22			—
Fixed Income:
Securities		346			—		284			62
Overlay derivatives liabilities		(12	)		—		(12	)		—
Cash Equivalents		38			—		38			—

Total	$	1,134		$	15	$	644		$	475

Plan assets using the fair value hierarchy as of December 31, 2012 were as follows:


	Total			Level 1		Level 2			Level 3
	(In millions)
Asset Class:
U.S. Equity:
Securities	$	122		$	49	$	—		$	73
Overlay derivatives liabilities		(8	)		—		(8	)		—
Global ex U.S. Equity:
Securities		93			—		93			—
Overlay derivatives liabilities		(6	)		—		(6	)		—
Global ex Emerging Markets Equity		41			—		25			16
Emerging Markets Equity:
Securities		43			—		43			—
Overlay derivatives liabilities		(3	)		—		(3	)		—
Absolute Return Hedge Funds		150			—		40			110
Equity Hedge Funds		123			—		62			61
Private Equity		51			—		—			51
Private Real Assets		24			—		—			24
Public Real Assets		23			—		14			9
Fixed Income:
Securities		375			241		69			65
Overlay derivatives assets		27			—		27			—
Cash Equivalents		23			—		23			—

Total	$	1,078		$	290	$	379		$	409

Equity securities are valued primarily using a market approach based on the quoted market prices of identical instruments. Certain equity securities are valued at their net asset value (“NAV”) per share.

Real estate values are based on market based comparable data or at their NAVs.

Fixed income securities are valued primarily using a market approach with inputs based on the quoted market prices of identical instruments and that include broker quotes in a non-active market.

Cash equivalents are held primarily in registered money market funds which are valued at their NAVs calculated using the amortized cost of the securities and have daily liquidity.

Certain of our plan assets, classified in U.S. Equity Securities, Absolute Return Hedge Funds, Equity Hedge Funds, Private Equity, Private Real Assets and Fixed Income Securities, do not have readily determinable market values given the specific investment structures involved and the nature of the underlying investments. For the December 31, 2013 and 2012 plan asset reporting, publicly traded asset pricing was used where possible. For assets without readily determinable values, reported NAVs or their equivalent were provided by the respective investment sponsors or investment manager and subsequently reviewed and approved by management. For those investments reported on a one-quarter lagged basis (primarily Private Equity and Private Real Assets), NAVs or their equivalent are adjusted for subsequent cash flows and significant events.

The following table presents a reconciliation of Level 3 assets held during the year ended December 31, 2013. For the year ended December 31, 2013, there were no significant transfers between levels 1, 2 and 3.


	January 1, 2013 Balance		Realized Gains/ (Losses)			Unrealized Gains/ (Losses)			Purchases		Sales			Net Transfers Into/(Out of) Level 3		December 31, 2013 Balance
US Equity	$	73	$	(1	)	$	23		$	9	$	(8	)	$	—	$	96
Global ex Emerging Markets Equity		16		—			6			—		—			—		22
Absolute Return Hedge Funds		110		2			16			12		(10	)		—		130
Equity Hedge Funds		61		—			11			25		(16	)		—		81
Private Equity		51		3			5			6		(14	)		—		51
Private Real Assets		24		2			4			11		(8	)		—		33
Public Real Assets		9		(1	)		1			—		(9	)		—		—
Fixed Income		65		—			(3	)		—		—			—		62

The following table presents a reconciliation of Level 3 assets held during the year ended December 31, 2012. For the year ended December 31, 2012, there were no significant transfers between levels 1, 2 and 3.


	January 1, 2012 Balance		Realized Gains/ (Losses)		Unrealized Gains/ (Losses)		Purchases		Sales			Net Transfers Into/(Out of) Level 3			December 31, 2012 Balance
US Equity	$	66	$	—	$	12	$	—	$	(5	)	$	—		$	73
Global ex Emerging Markets Equity		—		—		1		15		—			—			16
Absolute Return Hedge Funds		80		2		7		29		(8	)		—			110
Equity Hedge Funds		50		—		2		13		(4	)		—			61
Private Equity		47		1		5		9		(10	)		(1	)		51
Private Real Assets		16		1		1		10		(4	)		—			24
Public Real Assets		9		—		—		—		—			—			9
Fixed Income		—		—		—		65		—			—			65

Profit Sharing—Lorillard has a Profit Sharing Plan for hourly employees. Lorillard’s contributions under this plan are based on Lorillard’s performance with a maximum contribution of 15% of participants’ earnings. Contributions for 2013, 2012, and 2011 were $11 million, $11 million, and $11 million, respectively.

Savings Plan—Lorillard sponsors an Employees Savings Plan for salaried employees. Lorillard provides a matching contribution of 100% of the first 3% of pay contributed and 50% of the next 2% of pay contributed by employees. Lorillard contributions for 2013, 2012, and 2011 were $5 million, $5 million, and $5 million, respectively.