Retirement Plans and Other Postretirement Benefits

Pinnacle West sponsors a qualified defined benefit and account balance pension plan (The Pinnacle West Capital Corporation Retirement Plan) and a non-qualified supplemental excess benefit retirement plan for the employees of Pinnacle West and its subsidiaries. All new employees participate in the account balance plan. Defined benefit plans specify the amount of benefits a plan participant is to receive using information about the participant. The pension plan covers nearly all employees. The supplemental excess benefit retirement plan covers officers of the Company and highly compensated employees designated for participation by the Board of Directors. Our employees do not contribute to the plans. We calculate the benefits based on age, years of service and pay.

Pinnacle West also sponsors other postretirement benefit plans (Pinnacle West Capital Corporation Group Life and Medical Plan and Pinnacle West Capital Corporation Post-65 Retiree Health Reimbursement Arrangement) for the employees of Pinnacle West and its subsidiaries. These plans provide medical and life insurance benefits to retired employees. Employees must retire to become eligible for these retirement benefits, which are based on years of service and age. For the medical insurance plan, retirees make contributions to cover a portion of the plan costs. For the life insurance plan, retirees do not make contributions. We retain the right to change or eliminate these benefits.

On September 30, 2014, Pinnacle West announced plan design changes to the other postretirement benefit plan, which required an interim remeasurement of the benefit obligation for the plan. Effective January 1, 2015, those eligible retirees and dependents over age 65 and on Medicare can choose to be enrolled in a Health Reimbursement Arrangement (HRA). The Company is providing a subsidy allowing post-65 retirees to purchase a Medicare supplement plan on a private exchange network. The remeasurement of the benefit obligation included updating the assumptions. The remeasurement reduced net periodic benefit costs in 2014 by $10 million ($5 million of which reduced expense). The remeasurement also resulted in a decrease in Pinnacle West’s other postretirement benefit obligation of $316 million, which was offset by the related regulatory asset and accumulated other comprehensive income.

Because of the plan changes, the Company is currently in the process of seeking IRS approval to move up to $140 million of the other postretirement benefit trust assets into a new trust account to pay for active union employee medical costs. In December 2016, FERC approved a methodology for determining the amount of other postretirement benefit trust assets to move into a new account to pay for active union employee medical costs. As of December 31, 2016, such methodology would result in an amount of approximately $140 million being transferred to the new account.

Pinnacle West uses a December 31 measurement date each year for its pension and other postretirement benefit plans. The market-related value of our plan assets is their fair value at the measurement date. See Note 13 for further discussion of how fair values are determined. Due to subjective and complex judgments, which may be required in determining fair values, actual results could differ from the results estimated through the application of these methods.

A significant portion of the changes in the actuarial gains and losses of our pension and postretirement plans is attributable to APS and therefore is recoverable in rates. Accordingly, these changes are recorded as a regulatory asset or regulatory liability. In its 2009 retail rate case settlement, APS received approval to defer a portion of pension and other postretirement benefit cost increases incurred in 2011 and 2012. We deferred pension and other postretirement benefit costs of approximately $14 million in 2012 and $11 million in 2011. Pursuant to an ACC regulatory order, we began amortizing the regulatory asset over three years beginning in July 2012. We amortized approximately $5 million in 2015, $8 million in 2014, $8 million in 2013 and $4 million in 2012.

The following table provides details of the plans’ net periodic benefit costs and the portion of these costs charged to expense (including administrative costs and excluding amounts capitalized as overhead construction, billed to electric plant participants or charged to the regulatory asset or liability) (dollars in thousands):



	Pension									Other Benefits
	2016			2015			2014			2016			2015			2014
Service cost-benefits earned during the period	$	53,792		$	59,627		$	53,080		$	14,993		$	16,827		$	18,139
Interest cost on benefit obligation	131,647			123,983			129,194			29,721			28,102			41,243
Expected return on plan assets	(173,906		)	(179,231		)	(158,998		)	(36,495		)	(36,855		)	(46,400		)
Amortization of:
Prior service cost (credit)	527			594			869			(37,883		)	(37,968		)	(9,626		)
Net actuarial loss	40,717			31,056			10,963			4,589			4,881			1,175
Net periodic benefit cost	$	52,777		$	36,029		$	35,108		$	(25,075	)	$	(25,013	)	$	4,531
Portion of cost charged to expense	$	26,172		$	20,036		$	21,985		$	(12,435	)	$	(10,391	)	$	6,000

The following table shows the plans’ changes in the benefit obligations and funded status for the years 2016 and 2015 (dollars in thousands):



	Pension						Other Benefits
	2016			2015			2016			2015
Change in Benefit Obligation
Benefit obligation at January 1	$	3,033,803		$	3,078,648		$	647,020		$	682,335
Service cost	53,792			59,627			14,993			16,827
Interest cost	131,647			123,983			29,721			28,102
Benefit payments	(142,247		)	(137,115		)	(26,231		)	(24,988		)
Actuarial (gain) loss	127,467			(91,340		)	50,942			(55,256		)
Benefit obligation at December 31	3,204,462			3,033,803			716,445			647,020
Change in Plan Assets
Fair value of plan assets at January 1	2,542,774			2,615,404			833,017			834,625
Actual return on plan assets	166,408			(44,690		)	63,463			(2,399		)
Employer contributions	100,000			100,000			819			791
Benefit payments	(133,825		)	(127,940		)	(14,648		)	—
Fair value of plan assets at December 31	2,675,357			2,542,774			882,651			833,017
Funded Status at December 31	$	(529,105	)	$	(491,029	)	$	166,206		$	185,997

The following table shows the projected benefit obligation and the accumulated benefit obligation for pension plans with an accumulated obligation in excess of plan assets as of December 31, 2016 and 2015 (dollars in thousands):



	2016		2015
Projected benefit obligation	$	3,204,462	$	3,033,803
Accumulated benefit obligation	3,049,406		2,873,467
Fair value of plan assets	2,675,357		2,542,774

The following table shows the amounts recognized on the Consolidated Balance Sheets as of December 31, 2016 and 2015 (dollars in thousands):



	Pension						Other Benefits
	2016			2015			2016		2015
Noncurrent asset	$	—		$	—		$	166,206	$	185,997
Current liability	(19,795		)	(10,031		)	—		—
Noncurrent liability	(509,310		)	(480,998		)	—		—
Net amount recognized	$	(529,105	)	$	(491,029	)	$	166,206	$	185,997

The following table shows the details related to accumulated other comprehensive loss as of December 31, 2016 and 2015 (dollars in thousands):



	Pension						Other Benefits
	2016			2015			2016			2015
Net actuarial loss	$	773,750		$	679,501		$	146,509		$	127,124
Prior service cost (credit)	81			609			(303,417		)	(341,301		)
APS’s portion recorded as a regulatory (asset) liability	(711,059		)	(619,223		)	156,575			213,621
Income tax expense (benefit)	(24,202		)	(23,663		)	833			925
Accumulated other comprehensive loss	$	38,570		$	37,224		$	500		$	369

The following table shows the estimated amounts that will be amortized from accumulated other comprehensive loss and regulatory assets and liabilities into net periodic benefit cost in 2017 (dollars in thousands):



	Pension		Other Benefits
Net actuarial loss	$	46,971	$	5,181
Prior service cost (credit)	81		(37,842		)
Total amounts estimated to be amortized from accumulated other comprehensive loss (gain) and regulatory assets (liabilities) in 2017	$	47,052	$	(32,661	)

The following table shows the weighted-average assumptions used for both the pension and other benefits to determine benefit obligations and net periodic benefit costs:



	Benefit Obligations As of December 31,				Benefit Costs For the Years Ended December 31,
	2016		2015		2016		2015		2014
									January - September		October - December
Discount rate – pension	4.08	%	4.37	%	4.37	%	4.02	%	4.88	%	4.88	%
Discount rate – other benefits	4.17	%	4.52	%	4.52	%	4.14	%	5.10	%	4.41	%
Rate of compensation increase	4.00	%	4.00	%	4.00	%	4.00	%	4.00	%	4.00	%
Expected long-term return on plan assets - pension	N/A		N/A		6.90	%	6.90	%	6.90	%	6.90	%
Expected long-term return on plan assets - other benefits	N/A		N/A		4.45	%	4.45	%	6.80	%	4.25	%
Initial healthcare cost trend rate (pre-65 participants)	7.00	%	7.00	%	7.00	%	7.00	%	7.50	%	7.50	%
Initial healthcare cost trend rate (post-65 participants)	5.00	%	5.00	%	5.00	%	5.00	%	7.50	%	5.00	%
Ultimate healthcare cost trend rate	5.00	%	5.00	%	5.00	%	5.00	%	5.00	%	5.00	%
Number of years to ultimate trend rate (pre-65 participants)	4		4		4		4		4		4
Number of years to ultimate trend rate (post-65 participants)	0		0		0		0		4		0

In selecting the pretax expected long-term rate of return on plan assets, we consider past performance and economic forecasts for the types of investments held by the plan. For 2017, we are assuming a 6.55% long-term rate of return for pension assets and 6.37% (before tax) for other benefit assets, which we believe is reasonable given our asset allocation in relation to historical and expected performance.

In October 2014, the Society of Actuaries’ Retirement Plans Experience Committee issued its final reports on its recommended mortality basis (“RP-2014 Mortality Tables Report” and "Mortality Improvement Scale MP-2014 Report"). At December 31, 2014, we updated our mortality assumptions using the recommended basis with modifications to better reflect our plan experience and additional data regarding mortality trends. The updated mortality assumptions resulted in a $67 million increase in Pinnacle West’s pension and other postretirement obligations, which was offset by the related regulatory asset, regulatory liability and accumulated other comprehensive income.

In selecting our healthcare trend rates, we consider past performance and forecasts of healthcare costs. A one percentage point change in the assumed initial and ultimate healthcare cost trend rates would have the following effects (dollars in thousands):



	1% Increase		1% Decrease
Effect on other postretirement benefits expense, after consideration of amounts capitalized or billed to electric plant participants	$	8,430	$	(5,455	)
Effect on service and interest cost components of net periodic other postretirement benefit costs	8,440		(6,527		)
Effect on the accumulated other postretirement benefit obligation	108,046		(86,651		)

Plan Assets

The Board of Directors has delegated oversight of the pension and other postretirement benefit plans’ assets to an Investment Management Committee (“Committee”). The Committee has adopted investment policy statements (“IPS”) for the pension and the other postretirement benefit plans’ assets. The investment strategies for these plans include external management of plan assets, and prohibition of investments in Pinnacle West securities.

The overall strategy of the pension plan’s IPS is to achieve an adequate level of trust assets relative to the benefit obligations. To achieve this objective, the plan’s investment policy provides for mixes of investments including long-term fixed income assets and return-generating assets. The target allocation between return-generating and long-term fixed income assets is defined in the IPS and is a function of the plan’s funded status. The plan’s funded status is reviewed on at least a monthly basis.

Changes in the value of long-term fixed income assets, also known as liability-hedging assets, are intended to offset changes in the benefit obligations due to changes in interest rates. Long-term fixed income assets consist primarily of fixed income debt securities issued by the U.S. Treasury and other government agencies, U.S Treasury Futures Contracts, and fixed income debt securities issued by corporations. Long-term fixed income assets may also include interest rate swaps, and other instruments.

Return-generating assets are intended to provide a reasonable long-term rate of investment return with a prudent level of volatility. Return-generating assets are composed of U.S. equities, international equities, and alternative investments. International equities include investments in both developed and emerging markets. Alternative investments include investments in real estate, private equity and various other strategies. The plan may also hold investments in return-generating assets by holding securities in partnerships, common and collective trusts and mutual funds.

Based on the IPS, and given the pension plan’s funded status at year-end 2016, the long-term fixed income assets had a target allocation of 58% with a permissible range of 55% to 61% and the return-generating assets had a target allocation of 42% with a permissible range of 39% to 45%. The return-generating assets have additional target allocations, as a percent of total plan assets, of 22% equities in U.S. and other developed markets, 6% equities in emerging markets, and 14% in alternative investments. The pension plan IPS does not provide for a specific mix of long-term fixed income assets, but does expect the average credit quality of such assets to be investment grade. As of December 31, 2016, long-term fixed income assets represented 57% of total pension plan assets, and return-generating assets represented 43% of total pension plan assets.

As of December 31, 2016, the asset allocation for other postretirement benefit plan assets is governed by the IPS for those plans, which provides for different asset allocation target mixes depending on the characteristics of the liability. Some of these asset allocation target mixes vary with the plan’s funded status. As of December 31, 2016, investment in fixed income assets represented 51% of the other postretirement benefit plan total assets, and non-fixed income assets represented 49% of the other postretirement benefit plan’s assets.

See Note 13 for a discussion on the fair value hierarchy and how fair value methodologies are applied. The plans invest directly in fixed income, U.S Treasury Futures Contracts, and equity securities, in addition to investing indirectly in fixed income securities, equity securities and real estate through the use of mutual funds, partnerships and common and collective trusts. Equity securities held directly by the plans are valued using quoted active market prices from the published exchange on which the equity security trades, and are classified as Level 1. U.S Treasury Future Contracts are valued using the quoted active market prices from the exchange on which they trade, and are classified as Level 1. Fixed income securities issued by the U.S. Treasury held directly by the plans are valued using quoted active market prices, and are classified as Level 1. Fixed income securities issued by corporations, municipalities, and other agencies are primarily valued using quoted inactive market prices, or quoted active market prices for similar securities, or by utilizing calculations which incorporate observable inputs such as yield, maturity and credit quality. These instruments are classified as Level 2.

Mutual funds, partnerships, and common and collective trusts are valued utilizing a net asset value (NAV) concept or its equivalent. Mutual funds, classified as Level 1, are valued using a NAV that is observable and based on the active market in which the fund trades.

Common and collective trusts, are maintained by banks or investment companies and hold certain investments in accordance with a stated set of objectives (such as tracking the performance of the S&P 500 Index). The trust's shares are offered to a limited group of investors, and are not traded in an active market. Investments in common and collective trusts are valued using NAV, as a practical expedient and accordingly are not classified in the fair value hierarchy. The NAV for trusts investing in exchange traded equities is derived from the quoted active market prices of the underlying securities held by the trusts. The NAV for trusts investing in real estate is derived from the appraised values of the trust's underlying real estate assets. As of December 31, 2016, the plans were able to transact in the common and collective trusts at NAV.

Investments in partnerships are also valued using the concept of NAV, as a practical expedient and accordingly are not classified in the fair value hierarchy. The NAV for these investments is derived from the value of the partnerships' underlying assets. The plan's partnerships holdings relate to investments in high-yield fixed income instruments and assets of privately held portfolio companies. Certain partnerships also include funding commitments that may require the plan to contribute up to $75 million to these partnerships; as of December 31, 2016, approximately $54 million of these commitments have been funded.

The plans’ trustee provides valuation of our plan assets by using pricing services that utilize methodologies described to determine fair market value. We have internal control procedures to ensure this information is consistent with fair value accounting guidance. These procedures include assessing valuations using an independent pricing source, verifying that pricing can be supported by actual recent market transactions, assessing hierarchy classifications, comparing investment returns with benchmarks, and obtaining and reviewing independent audit reports on the trustee’s internal operating controls and valuation processes.

The fair value of Pinnacle West’s pension plan and other postretirement benefit plan assets at December 31, 2016, by asset category, are as follows (dollars in thousands):



	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Other (a)		Balance at December 31, 2016
Pension Plan:
Cash and cash equivalents	$	13,995	$	—	$	—	$	13,995
Fixed income securities:
Corporate	—		1,210,453		—		1,210,453
U.S. Treasury	112,583		—		—		112,583
Other (b)	—		102,170		—		102,170
Common stock equities (c)	235,109		—		—		235,109
Mutual funds (d)	251,506		—		—		251,506
Common and collective trusts:
Equities	—		—		266,840		266,840
Real estate	—		—		161,449		161,449
Partnerships	—		—		208,915		208,915
Short-term investments and other (e)	—		—		112,337		112,337
Total	$	613,193	$	1,312,623	$	749,541	$	2,675,357
Other Benefits:
Cash and cash equivalents	$	304	$	—	$	—	$	304
Fixed income securities:
Corporate	—		268,193		—		268,193
U.S. Treasury	145,255		—		—		145,255
Other (b)	—		34,506		—		34,506
Common stock equities (c)	243,741		—		—		243,741
Mutual funds (d)	67,418		—		—		67,418
Common and collective trusts:
Equities	—		—		95,814		95,814
Real estate	—		—		14,509		14,509
Partnerships	—		—		3,060		3,060
Short-term investments and other (e)	—		—		9,851		9,851
Total	$	456,718	$	302,699	$	123,234	$	882,651


(a)	These investments primarily represent assets valued using net asset value as a practical expedient, and have not been classified in the fair value hierarchy.


(b)	This category consists primarily of debt securities issued by municipalities.


(c)	This category primarily consists of US common stock equities.


(d)	These funds invest in US and international common stock equities.


(e)	This category includes plan receivables and payables.

The fair value of Pinnacle West’s pension plan and other postretirement benefit plan assets at December 31, 2015, by asset category, are as follows (dollars in thousands):



	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Other (a)		Balance at December 31, 2015
Pension Plan:
Cash and cash equivalents	$	1,893	$	—	$	—	$	1,893
Fixed Income Securities:
Corporate	—		1,108,736		—		1,108,736
U.S. Treasury	274,778		—		—		274,778
Other (b)	—		113,008		—		113,008
Common stock equities (c)	247,701		—		—		247,701
Mutual funds - International equities	116,307		—		—		116,307
Common and collective trusts:
Equities	—		—		315,989		315,989
Real Estate	—		—		150,359		150,359
Partnerships	—		—		169,937		169,937
Short-term investments and other (d)	—		—		44,066		44,066
Total	$	640,679	$	1,221,744	$	680,351	$	2,542,774
Other Benefits:
Cash and cash equivalents	$	240	$	—	$	—	$	240
Fixed Income Securities:
Corporate	—		217,026		—		217,026
U.S. Treasury	131,435		—		—		131,435
Other (b)	—		31,106		—		31,106
Common stock equities (c)	265,583		—		—		265,583
Mutual funds - International equities	52,568		—		—		52,568
Common and collective trusts:
Equities	—		—		110,055		110,055
Real Estate	—		—		13,512		13,512
Short-term investments and other (d)	—		—		11,492		11,492
Total	$	449,826	$	248,132	$	135,059	$	833,017


(a)	These investments primarily represent assets valued using net asset value as a practical expedient, and have not been classified in the fair value hierarchy.


(b)	This category consists primarily of debt securities issued by municipalities.


(c)	This category primarily consists of US common stock equities.


(d)	This category includes plan receivables and payables.

Contributions

Future year contribution amounts are dependent on plan asset performance and plan actuarial assumptions. We made contributions to our pension plan totaling $100 million in 2016, $100 million in 2015, and $175 million in 2014. The minimum required contributions for the pension plan are zero for the next three years. We expect to make voluntary contributions up to a total of $300 million during the 2017-2019 period. With regard to contributions to our other postretirement benefit plans, we made a contribution of approximately $1 million in each of 2016, 2015 and 2014. We expect to make contributions of less than $1 million in total for the next three years to our other postretirement benefit plans. APS funds its share of the contributions. APS’s share of the pension plan contribution was approximately $100 million in 2016, $100 million in 2015 and $175 million in 2014. APS’s share of the contributions to the other postretirement benefit plan was approximately $1 million in 2016, 2015 and 2014.

Estimated Future Benefit Payments

Benefit payments, which reflect estimated future employee service, for the next five years and the succeeding five years thereafter, are estimated to be as follows (dollars in thousands):



Year	Pension		Other Benefits
2017	$	172,859	$	31,126
2018	173,232		33,795
2019	182,944		36,195
2020	191,037		37,998
2021	196,292		39,368
Years 2022-2026	1,049,149		201,944

Electric plant participants contribute to the above amounts in accordance with their respective participation agreements.

Employee Savings Plan Benefits

Pinnacle West sponsors a defined contribution savings plan for eligible employees of Pinnacle West and its subsidiaries. In 2016, costs related to APS’s employees represented 99% of the total cost of this plan. In a defined contribution savings plan, the benefits a participant receives result from regular contributions participants make to their own individual account, the Company’s matching contributions and earnings or losses on their investments. Under this plan, the Company matches a percentage of the participants’ contributions in cash which is then invested in the same investment mix as participants elect to invest their own future contributions. Pinnacle West recorded expenses for this plan of approximately $10 million for 2016, $9 million for 2015, and $9 million for 2014.