Employee Benefits

We have a number of defined benefit pension plans and defined contribution plans covering substantially all employees. Our primary U.S. pension plan is a noncontributory plan under which benefits are based on employee career employment compensation. In December 2011, our Board of Directors approved a plan amendment that froze our U.S. employee retirement plan (“U.S. ERP”) effective on April 1, 2012. Our U.S. ERP is a defined benefit plan. Under the amendment, no new employees will be permitted to enter the U.S. ERP and no additional benefits for current participants for future services will be accrued.

We also have unfunded non-U.S. and supplemental benefit plans. The supplemental benefit plans provide senior management with supplemental retirement, disability and death benefits. Certain supplemental retirement benefits are based on final monthly earnings. In addition, we sponsor voluntary 401(k) plans under which we may match employee contributions up to certain levels of compensation as well as profit-sharing plans under which we contribute a percentage of eligible employees’ compensation to the employees’ accounts.

We also provide certain postretirement medical, dental and life insurance benefits for retired employees and eligible dependents. The medical and dental plans are contributory while the life insurance plan is noncontributory. We currently do not prefund any of these plans.

We recognize the funded status of our retirement and postretirement plans in the consolidated balance sheets, with a corresponding adjustment to accumulated other comprehensive income, net of taxes. The amounts in accumulated other comprehensive income represent net unrecognized actuarial losses and unrecognized prior service costs. These amounts will be subsequently recognized as net periodic pension cost pursuant to our accounting policy for amortizing such amounts.

As part of the definitive agreement to sell MHE to investment funds affiliated with Apollo Global Management, LLC, described further in Note 2 – Growth and Value Plan & Discontinued Operations, we will retain the benefit obligations and plan assets related to MHE, however, the benefit cost for periods presented is bifurcated between continuing and discontinued operations.

Benefit Obligation

A summary of the benefit obligation and the fair value of plan assets, as well as the funded status for the retirement and postretirement plans as of December 31, is as follows (benefits paid in the table below include only those amounts contributed directly to or paid directly from plan assets):



(in millions)	Retirement Plans						Postretirement Plans
	2012			2011			2012			2011
Net benefit obligation at beginning of year	$	1,834		$	1,794		$	129		$	144
Service cost	24			67			3			3
Interest cost	93			99			5			6
Plan participants’ contributions	1			1			5			5
Actuarial loss (gain)	287			59			3			(14		)
Gross benefits paid	(71		)	(63		)	(17		)	(16		)
Plan amendments ¹	—			(129		)	—			—
Foreign currency effect	11			3			—			—
Federal subsidy benefits received	—			—			1			1
Other adjustments	(8		)	3			—			—
Net benefit obligation at end of year	2,171			1,834			129			129
Fair value of plan assets at beginning of year	1,505			1,567			—			—
Actual return on plan assets	212			(31		)	—			—
Employer contributions	193			29			12			10
Plan participants’ contributions	1			1			5			6
Gross benefits paid	(71		)	(63		)	(17		)	(16		)
Foreign currency effect	11			2			—			—
Fair value of plan assets at end of year	1,851			1,505			—			—
Funded status	$	(320	)	$	(329	)	$	(129	)	$	(129	)
Amounts recognized in consolidated balance sheets
Non-current assets	$	97		$	68		$	—		$	—
Current liabilities	(6		)	(6		)	(11		)	(9		)
Non-current liabilities	(411		)	(391		)	(118		)	(120		)
	$	(320	)	$	(329	)	$	(129	)	$	(129	)
Accumulated benefit obligation	$	2,093		$	1,773
Plans with accumulated benefit obligation in excess of the fair value of plan assets
Projected benefit obligation	$	1,773		$	1,487
Accumulated benefit obligation	$	1,756		$	1,480
Fair value of plan assets	$	1,356		$	1,090
Amounts recognized in accumulated other comprehensive loss, net of tax
Net actuarial loss (gain)	$	455		$	359		$	(3	)	$	(5	)
Prior service credit	(4		)	(6		)	(1		)	(2		)
Total recognized	$	451		$	353		$	(4	)	$	(7	)

In December 2011, our Board of Directors approved a plan amendment that froze our U.S. ERP effective on April 1, 2012. This amendment decreased our pension benefit liabilities by $129 million, and resulted in an after-tax decrease in accumulated other comprehensive loss of $82 million. We also recorded an immaterial amount of pension plan curtailment expense in 2011 as a result of the plan amendment.

The actuarial loss included in accumulated other comprehensive loss for our retirement plans and expected to be recognized in net periodic pension cost during the year ending December 31, 2013 is $25 million. There is an immaterial amount of prior service credit included in accumulated other comprehensive loss for our retirement plans expected to be recognized in net periodic benefit cost during the year ending December 31, 2013.

The prior service credit included in accumulated other comprehensive loss for our postretirement plans and expected to be recognized in net periodic benefit cost during the year ending December 31, 2013 is $1 million. There is no actuarial loss in accumulated other comprehensive loss for our postretirement plans expected to be recognized in net periodic benefit cost during the year ending December 31, 2013.

Net Periodic Cost

For purposes of determining annual pension cost, prior service costs are being amortized straight-line over the average remaining service period of employees expected to receive benefits.

A summary of net periodic benefit cost for our retirement and postretirement plans for the years ended December 31, is as follows:



(in millions)	Retirement Plans									Postretirement Plans
	2012			2011			2010			2012			2011			2010
Service cost	$	24		$	67		$	61		$	3		$	3		$	3
Interest cost	93			99			94			5			6			7
Expected return on assets	(124		)	(127		)	(112		)	—			—			—
Amortization of:
Actuarial loss	32			31			15			—			—			—
Prior service credit	(1		)	—			—			(1		)	(1		)	(1		)
Net periodic benefit cost	$	24		$	70		$	58		$	7		$	8		$	9

Our United Kingdom (“U.K.”) retirement plan accounted for $3 million in 2012 and 2011 and $6 million in 2010 of the net periodic benefit cost attributable to the funded plans.

Other changes in plan assets and benefit obligations recognized in other comprehensive income, net of tax for the years ended December 31, are as follows:



(in millions)	Retirement Plans									Postretirement Plans
	2012			2011			2010			2012		2011			2010
Net actuarial loss (gain)	$	116		$	65		$	41		$	2	$	(12	)	$	(6	)
Recognized actuarial gain	(20		)	(18		)	(9		)	—		—			—
Prior service credit	2			—			—			1		1			1
Total recognized	$	98		$	47		$	32		$	3	$	(11	)	$	(5	)

The total cost for our retirement plans was $129 million for 2012, $175 million for 2011 and $156 million for 2010. Included in the total retirement plans cost are defined contribution plans cost of $86 million for 2012, $88 million for 2011 and $83 million 2010.

Assumptions



	Retirement Plans						Postretirement Plans
	2012		2011		2010		2012		2011		2010
Benefit obligation: ¹
Discount rate	4.1	%	5.1	%	5.4	%	3.45	%	4.45	%	4.7	%
Compensation increase factor	N/A		4.5	%	4.5	%
Net periodic cost:
Weighted-average healthcare cost rate ²							7.5	%	8.0	%	8.0	%
Discount rate - U.S. plan ³	5.1	%	5.4	%	5.95	%	4.45	%	4.65	%	5.3	%
Discount rate - U.K. plan ³	5.1	%	5.5	%	5.9	%
Compensation increase factor - U.S. plan	4.5	%	4.5	%	5.5	%
Compensation increase factor - U.K. plan	5.85	%	6.25	%	6.25	%
Return on assets ⁴	7.75	%	8.0	%	8.0	%


¹	These assumptions for the retirement plans relate to our U.S. ERP and a compensation increase factor is no longer applicable for 2012 because there are no further salary increases as the U.S. ERP was frozen in April 2012.


²	The assumed weighted-average healthcare cost trend rate will decrease ratably from 7.5% in 2012 to 5% in 2018 and remain at that level thereafter. Assumed healthcare cost trends have an effect on the amounts reported for the healthcare plans. A one percentage point change in assumed healthcare cost trend creates the following effects:



(in millions)	1% point increase		1% point decrease
Effect on postretirement obligation	$	4	$	(4	)


³	Effective January 1, 2013, we changed our discount rate assumption on our U.S. retirement plans to 4.1% from 5.1% in 2012 and changed our discount rate assumption on our U.K. plan to 4.8% from 5.1% in 2012.


⁴	The expected return on assets assumption is calculated based on the plan’s asset allocation strategy and projected market returns over the long-term. Effective January 1, 2013, we changed our return on assets assumption to 7.25% from 7.75% in 2012.

Cash Flows

In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was enacted. The Act established a prescription drug benefit under Medicare, known as “Medicare Part D”, and a federal subsidy to sponsors of retiree healthcare benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. Our benefits provided to certain participants are at least actuarially equivalent to Medicare Part D, and, accordingly, we are entitled to a subsidy.

Expected employer contributions in 2013 are $30 million for our retirement plans and $12 million for our postretirement plans. In 2013, we may elect to make additional non-required contributions depending on investment performance and the pension plan status. Information about the expected cash flows for our retirement and postretirement plans and the impact of the Medicare subsidy is as follows:



(in millions)			Postretirement Plans ²
	Retirement Plans ¹		Gross payments		Retiree contributions			Medicare subsidy			Net payments
2013	$	72	$	19	$	(7	)	$	(1	)	$	11
2014	75		21		(8		)	(1		)	12
2015	78		22		(10		)	(1		)	11
2016	82		24		(12		)	(1		)	11
2017	86		25		(14		)	(1		)	10
2018-2022	484		151		(98		)	(3		)	50


¹	Reflects the total benefits expected to be paid from the plans or from our assets including both our share of the benefit cost and the participants’ share of the cost.


²	Reflects the total benefits expected to be paid from our assets.

Fair Value of Plan Assets

In accordance with authoritative guidance for fair value measurements certain assets and liabilities are required to be recorded at fair value. Fair value is defined as the amount that would be received for selling an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value hierarchy has been established which requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs used to measure fair value are as follows:


•	Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities.


•	Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.


•	Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The fair value of our defined benefit plans assets as of December 31, 2012 and 2011, by asset class is as follows:



(in millions)	December 31, 2012
	Total		Level 1		Level 2		Level 3
Cash and short-term investments, and other	$	180	$	2	$	178	$	—
Equity securities:
U.S. indexes ¹	399		119		280		—
U.S. growth and value	344		307		37		—
U.K.	154		85		69		—
International, excluding U.K.	225		137		87		1
Fixed income securities:
Long duration strategy ²	370		—		370		—
Intermediate duration securities	3		—		3		—
Agency mortgage backed securities	13		—		13		—
Asset backed securities	10		—		10		—
Non-agency mortgage backed securities ³	52		—		52		—
U.K. ⁴	41		—		41		—
International, excluding U.K.	43		—		43		—
Real estate:
U.K. ⁵	17		—		—		17
Total	$	1,851	$	650	$	1,183	$	18



(in millions)	December 31, 2011
	Total		Level 1		Level 2		Level 3
Cash and short-term investments, and other	$	32	$	2	$	30	$	—
Equity securities:
U.S. indexes ¹	306		125		181		—
U.S. growth and value	370		370		—		—
U.K.	144		78		66		—
International, excluding U.K.	297		157		139		1
Fixed income securities:
Long duration strategy ²	195		—		195		—
Non-agency mortgage backed securities ³	66		—		66		—
U.K. ⁴	45		—		45		—
International, excluding U.K.	28		—		28		—
Real estate:
U.K. ⁵	22		—		—		22
Total	$	1,505	$	732	$	750	$	23


¹	Includes securities that are tracked in the following indexes: S&P 500, S&P MidCap 400, S&P MidCap 400 Growth and S&P Smallcap 600.


²	Includes securities that are investment grade obligations of issuers in the U.S.


³	Includes U.S. mortgage-backed securities that are not backed by the U.S. government.


⁴	Includes securities originated by the government of and other issuers from the U.K.


⁵	Includes a fund which holds real estate properties in the U.K.

For securities that are quoted in active markets, the trustee/custodian determines fair value by applying securities’ prices obtained from its pricing vendors. For commingled funds that are not actively traded, the trustee applies pricing information provided by investment management firms to the unit quantities of such funds. Investment management firms employ their own pricing vendors to value the securities underlying each commingled fund. Underlying securities that are not actively traded derive their prices from investment managers, which in turn, employ vendors that use pricing models (e.g. discounted cash flow, comparables). The domestic defined benefit plans have no investment in our stock, except through the S&P 500 commingled index fund.

The trustee obtains estimated prices from vendors for securities that are not easily quotable and they are categorized accordingly as Level 3. The following tables details further information our plan assets where we have used significant unobservable inputs (Level 3):



(in millions)
Beginning balance as of December 31, 2011	$	23
Capital distributions	(5		)
Ending balance as of December 31, 2012	$	18

Pension Trusts’ Asset Allocations

There are two pension trusts, one in the U.S. and one in the U.K.


•	The U.S. pension trust had assets of $1.5 billion and $1.2 billion as of December 31, 2012 and 2011, respectively, and the target allocations in 2013 include 50% domestic equities, 16% international equity securities, and 34% debt securities and short-term investments.


•	The U.K. pension trust had assets of $318 million and $258 million as of December 31, 2012 and 2011, respectively, and the target allocations in 2013 include 78% equities, 16% fixed income, and 6% U.K. real estate.

The pension assets are invested with the goal of producing a combination of capital growth and income. The mix of assets is established after consideration of the long-term performance and risk characteristics of asset classes. Investments are selected based on their potential to enhance returns, preserve capital, and reduce overall volatility. Holdings are diversified within each asset class. The portfolios employ a mix of index and actively managed equity strategies by market capitalization, style, geographic regions, and economic sectors. The fixed income strategies include U.S. long duration securities, opportunistic fixed income securities, and U.K. debt instruments. The short-term portfolio, whose primary goal is capital preservation for liquidity purposes, is composed of government and government-agency securities, un-invested cash, receivables, and payables. The portfolios do not employ any financial leverage.

U.S. Defined Contribution Plans

Assets of the defined contribution plans in the U.S. consist primarily of investment options which include actively managed equity, indexed equity, actively managed equity/bond funds, McGraw-Hill common stock, stable value, and money market strategies. There is also a self-directed mutual fund investment option. The plans purchased 620,455 and sold 869,199 shares of McGraw-Hill common stock in 2012 and purchased 695,632 and sold 796,934 shares of McGraw-Hill common stock in 2011. The plans held approximately 3.7 million shares of McGraw-Hill common stock as of December 31, 2012 and 4.0 million shares as of December 31, 2011, with market values of $200 million and $178 million, respectively. The plans received dividends on McGraw-Hill common stock of $13 million during the year ended December 31, 2012 and $4 million during the year ended December 31, 2011.