

(15) Employee Benefit Plans

Pension and Other Postretirement Benefit Plans

We sponsor and/or contribute to pension and postretirement health care and life insurance benefit plans for eligible employees, which includes two cash balance pension plans. The plan for our South Dakota and Nebraska employees is referred to as the NorthWestern Corporation pension plan, and the plan for our Montana employees is referred to as the NorthWestern Energy pension plan. We utilize a number of accounting mechanisms that reduce the volatility of reported pension costs. Differences between actuarial assumptions and actual plan results are deferred and are recognized into earnings only when the accumulated differences exceed 10% of the greater of the projected benefit obligation or the market-related value of plan assets. If necessary, the excess is amortized over the average remaining service period of active employees. The Plan’s funded status is recognized as an asset or liability in our Consolidated Financial Statements. See Note 5 - Regulatory Assets and Liabilities, for further discussion on how these costs are recovered through rates charged to our customers.

Benefit Obligation and Funded Status

Following is a reconciliation of the changes in plan benefit obligations and fair value of plan assets, and a statement of the funded status (in thousands):



	Pension Benefits						Other Postretirement Benefits
	December 31,						December 31,
	2016			2015			2016			2015
Change in benefit obligation:
Obligation at beginning of period	$	628,883		$	688,444		$	28,652		$	30,004
Service cost	11,759			12,362			492			526
Interest cost	26,210			26,174			795			786
Plan amendments	—			—			—			1,045
Actuarial loss (gain)	7,006			(47,351		)	(71		)	(616		)
Settlements	—			—			390			390
Benefits paid	(27,826		)	(50,746		)	(4,041		)	(3,483		)
Benefit Obligation at End of Period	$	646,032		$	628,883		$	26,217		$	28,652
Change in Fair Value of Plan Assets:
Fair value of plan assets at beginning of period	$	500,044		$	556,051		$	17,972		$	18,040
Return on plan assets	39,719			(15,461		)	1,277			—
Employer contributions	12,700			10,200			3,397			3,415
Benefits paid	(27,826		)	(50,746		)	(4,041		)	(3,483		)
Fair value of plan assets at end of period	$	524,637		$	500,044		$	18,605		$	17,972
Funded Status	$	(121,395	)	$	(128,839	)	$	(7,612	)	$	(10,680	)

Amounts Recognized in the Balance Sheet Consist of:
Current liability	—			—			(1,789		)	(2,584		)
Noncurrent liability	(121,395		)	(128,839		)	(5,823		)	(8,096		)
Net amount recognized	$	(121,395	)	$	(128,839	)	$	(7,612	)	$	(10,680	)

Amounts Recognized in Regulatory Assets Consist of:
Prior service (cost) credit	(9		)	(255		)	11,988			14,021
Net actuarial loss	(127,953		)	(142,305		)	(4,739		)	(5,219		)
Amounts recognized in AOCL consist of:
Prior service cost	—			—			(849		)	(1,000		)
Net actuarial gain	—			—			38			(102		)
Total	$	(127,962	)	$	(142,560	)	$	6,438		$	7,700

The total projected benefit obligation and fair value of plan assets for the pension plans with accumulated benefit obligations in excess of plan assets were as follows (in millions):



	Pension Benefits
	December 31,
	2016		2015
Projected benefit obligation	$	646.0	$	628.9
Accumulated benefit obligation	643.6		626.0
Fair value of plan assets	524.6		500.0

Net Periodic Cost (Credit)

The components of the net costs (credits) for our pension and other postretirement plans are as follows (in thousands):



	Pension Benefits									Other Postretirement Benefits
	December 31,									December 31,
	2016			2015			2014			2016			2015			2014
Components of Net Periodic Benefit Cost
Service cost	$	11,759		$	12,362		$	10,830		$	492		$	526		$	465
Interest cost	26,210			26,174			26,147			795			786			859
Expected return on plan assets	(28,248		)	(31,561		)	(29,506		)	(1,042		)	(969		)	(981		)
Amortization of prior service cost (credit)	246			246			246			(1,882		)	(1,882		)	(1,998		)
Recognized actuarial loss	9,888			10,634			2,118			315			385			348
Settlement loss recognized	—			—			—			390			390			690
Net Periodic Benefit Cost (Credit)	$	19,855		$	17,855		$	9,835		$	(932	)	$	(764	)	$	(617	)

For purposes of calculating the expected return on pension plan assets, the market-related value of assets is used, which is based upon fair value. The difference between actual plan asset returns and estimated plan asset returns are amortized equally over a period not to exceed five years.

We estimate amortizations from regulatory assets into net periodic benefit cost during 2017 will be as follows (in thousands):



	Pension Benefits			Other Postretirement Benefits
Prior service credit (cost)	$	(9	)	$	1,882
Accumulated loss	(7,901		)	(313		)

Actuarial Assumptions

The measurement dates used to determine pension and other postretirement benefit measurements for the plans are December 31, 2016 and 2015. The actuarial assumptions used to compute net periodic pension cost and postretirement benefit cost are based upon information available as of the beginning of the year, specifically, market interest rates, past experience and management's best estimate of future economic conditions. Changes in these assumptions may impact future benefit costs and obligations. In computing future costs and obligations, we must make assumptions about such things as employee mortality and turnover, expected salary and wage increases, discount rate, expected return on plan assets, and expected future cost increases. Two of these assumptions have the most impact on the level of cost: (1) discount rate and (2) expected rate of return on plan assets.

We set the discount rate using a yield curve analysis. This analysis includes constructing a hypothetical bond portfolio whose cash flow from coupons and maturities matches the year-by-year, projected benefit cash flow from our plans. The decrease in discount rate during 2016 increased our projected benefit obligation by approximately $16.1 million.

In determining the expected long-term rate of return on plan assets, we review historical returns, the future expectations for returns for each asset class weighted by the target asset allocation of the pension and postretirement portfolios, and long-term inflation assumptions. Based on the target asset allocation for our pension assets and future expectations for asset returns, we are lowering our long term rate of return on assets assumption to 4.70% for 2017.

The weighted-average assumptions used in calculating the preceding information are as follows:



	Pension Benefits						Other Postretirement Benefits
	December 31,						December 31,
	2016		2015		2014		2016		2015		2014
Discount rate	3.95-4.10	%	4.15-4.30	%	3.75-3.90	%	3.40-3.55	%	3.60-3.75	%	3.20-3.40	%
Expected rate of return on assets	5.80		5.80		5.80		5.80		5.80		5.80
Long-term rate of increase in compensation levels (nonunion)	3.28		3.58		3.58		3.28		3.58		3.58
Long-term rate of increase in compensation levels (union)	3.20		3.50		3.50		3.20		3.50		3.50

The postretirement benefit obligation is calculated assuming that health care costs increase by 7.59% in 2017 and the rate of increase in the per capita cost of covered health care benefits thereafter was assumed to decrease to an ultimate trend of 4.5% by the year 2038. The company contribution toward the premium cost is capped, therefore future health care cost trend rates are expected to have a minimal impact on company costs and the accumulated postretirement benefit obligation.

Investment Strategy

Our investment goals with respect to managing the pension and other postretirement assets are to meet current and future benefit payment needs while maximizing total investment returns (income and appreciation) after inflation within the constraints of diversification, prudent risk taking, and the Prudent Man Rule of the Employee Retirement Income Security Act of 1974. Each plan is diversified across asset classes to achieve optimal balance between risk and return and between income and growth through capital appreciation. Our investment philosophy is based on the following:


•	Each plan should be substantially fully invested as long-term cash holdings reduce long-term rates of return;


•	It is prudent to diversify each plan across the major asset classes;


•	Equity investments provide greater long-term returns than fixed income investments, although with greater short-term volatility;


•	Fixed income investments of the plans should strongly correlate with the interest rate sensitivity of the plan’s aggregate liabilities in order to hedge the risk of change in interest rates negatively impacting the overall funded status;


•	Allocation to foreign equities increases the portfolio diversification and thereby decreases portfolio risk while providing for the potential for enhanced long-term returns;


•	Active management can reduce portfolio risk and potentially add value through security selection strategies;


•	A portion of plan assets should be allocated to passive, indexed management funds to provide for greater diversification and lower cost; and


•	It is appropriate to retain more than one investment manager, provided that such managers offer asset class or style diversification.

Investment risk is measured and monitored on an ongoing basis through quarterly investment portfolio reviews, annual liability measurements, and periodic asset/liability studies.

The most important component of an investment strategy is the portfolio asset mix, or the allocation between the various classes of securities available. The mix of assets is based on an optimization study that identifies asset allocation targets in order to achieve the maximum return for an acceptable level of risk, while minimizing the expected contributions and pension and postretirement expense. In the optimization study, assumptions are formulated about characteristics, such as expected asset class investment returns, volatility (risk), and correlation coefficients among the various asset classes, and making adjustments to reflect future conditions expected to prevail over the study period. Based on this, the target asset allocation established, within an allowable range of plus or minus 5%, is as follows:



	Pension Benefits				Other Benefits
	December 31,				December 31,
	2016		2015		2016		2015
Domestic debt securities	55.0	%	55.0	%	40.0	%	40.0	%
International debt securities	5.0		5.0		—		—
Domestic equity securities	34.0		34.0		50.0		50.0
International equity securities	6.0		6.0		10.0		10.0

The actual allocation by plan is as follows:



	NorthWestern Energy Pension				NorthWestern Corporation Pension				NorthWestern Energy Health and Welfare
	December 31,				December 31,				December 31,
	2016		2015		2016		2015		2016		2015
Cash and cash equivalents	—	%	0.4	%	0.1	%	—	%	1.0	%	0.1	%
Domestic debt securities	53.4		54.9		64.4		65.8		37.0		37.0
International debt securities	4.6		4.7		4.4		4.5		—		—
Domestic equity securities	36.0		33.9		26.0		24.9		52.6		54.2
International equity securities	6.0		6.1		5.1		4.8		9.4		8.7
	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%

Generally, the asset mix will be rebalanced to the target mix as individual portfolios approach their minimum or maximum levels. Debt securities consist of U.S. and international instruments. Core domestic portfolios can be invested in government, corporate, asset-backed and mortgage-backed obligation securities. While the portfolio may invest in high yield securities, the average quality must be rated at least “investment grade" by rating agencies. Performance of fixed income investments is measured by both traditional investment benchmarks as well as relative changes in the present value of the plan's liabilities. Equity investments consist primarily of U.S. stocks including large, mid and small cap stocks, which are diversified across investment styles such as growth and value. We also invest in international equities with exposure to developing and emerging markets. Derivatives, options and futures are permitted for the purpose of reducing risk but may not be used for speculative purposes.

Our plan assets are primarily invested in common collective trusts (CCTs), which are invested in equity and fixed income securities. In accordance with our investment policy, these pooled investment funds must have an adequate asset base relative to their asset class and be invested in a diversified manner and have a minimum of three years of verified investment performance experience or verified portfolio manager investment experience in a particular investment strategy and have management and oversight by an investment advisor registered with the SEC. Investments in a collective investment vehicle are valued by multiplying the investee company’s net asset value per share with the number of units or shares owned at the valuation date. Net asset value per share is determined by the trustee. Investments held by the CCT, including collateral invested for securities on loan, are valued on the basis of valuations furnished by a pricing service approved by the CCT’s investment manager, which determines valuations using methods based on quoted closing market prices on national securities exchanges, or at fair value as determined in good faith by the CCT’s investment manager if applicable. The funds do not contain any redemption restrictions. The direct holding of NorthWestern Corporation stock is not permitted; however, any holding in a diversified mutual fund or collective investment fund is permitted. In addition, the NorthWestern Corporation pension plan assets also include a participating group annuity contract in the John Hancock General Investment Account, which consists primarily of fixed-income securities. The participating group annuity contract is valued based on discounted cash flows of current yields of similar contracts with comparable duration based on the underlying fixed income investments.

Cash Flows

In accordance with the Pension Protection Act of 2006 (PPA), and the relief provisions of the Worker, Retiree, and Employer Recovery Act of 2008 (WRERA), we are required to meet minimum funding levels in order to avoid required contributions and benefit restrictions. We have elected to use asset smoothing provided by the WRERA, which allows the use of asset averaging, including expected returns (subject to certain limitations), for a 24-month period in the determination of funding requirements. We expect to continue to make contributions to the pension plans in 2017 and future years that reflect the minimum requirements and discretionary amounts consistent with the amounts recovered in rates. Additional legislative or regulatory measures, as well as fluctuations in financial market conditions, may impact our funding requirements.

Due to the regulatory treatment of pension costs in Montana, pension expense for 2016, 2015 and 2014 was based on actual contributions to the plan. Annual contributions to each of the pension plans are as follows (in thousands):



	2016		2015		2014
NorthWestern Energy Pension Plan (MT)	$	11,500	$	9,000	$	9,000
NorthWestern Corporation Pension Plan (SD and NE)	1,200		1,200		1,200
	$	12,700	$	10,200	$	10,200

We estimate the plans will make future benefit payments to participants as follows (in thousands):



	Pension Benefits		Other Postretirement Benefits
2017	$	30,637	$	3,513
2018	32,346		3,464
2019	33,574		3,218
2020	34,847		2,844
2021	35,906		2,634
2022-2026	198,236		9,195

Defined Contribution Plan

Our defined contribution plan permits employees to defer receipt of compensation as provided in Section 401(k) of the Internal Revenue Code. Under the plan, employees may elect to direct a percentage of their gross compensation to be contributed to the plan. We contribute various percentage amounts of the employee's gross compensation contributed to the plan. Matching contributions for the year ended December 31, 2016, 2015 and 2014 were $9.8 million, $9.5 million, and $8.7 million.