EMPLOYEE BENEFIT PLANS

Four defined-benefit and five defined-contribution retirement plans cover various employee groups of Alaska and Horizon. The defined-benefit plans provide benefits based on an employee’s term of service and average compensation for a specified period of time before retirement. The qualified defined-benefit pension plans are closed to new entrants.

Accounting standards require recognition of the overfunded or underfunded status of an entity’s defined-benefit pension and other postretirement plan as an asset or liability in the financial statements and requires recognition of the funded status in AOCL.

Qualified Defined-Benefit Pension Plans

The Company’s pension plans are funded as required by the Employee Retirement Income Security Act of 1974 (ERISA).

The defined-benefit plan assets consist primarily of marketable equity and fixed-income securities. The Company uses a December 31 measurement date for these plans.

Weighted average assumptions used to determine benefit obligations as of December 31:

Discount rates of 3.95% and 4.65% were used as of December 31, 2012 and 2011, respectively. For 2012, the rate of compensation increase used varied from 3.05% to 4.02%, depending on the related work group. For 2011, the rate of compensation increases was 2.94% to 4.17%.

Weighted average assumptions used to determine net periodic benefit cost for the years ended December 31:

Discount rates of 4.65%, 5.55%, and 5.85% were used for the years ended December 31, 2012, 2011, and 2010, respectively. Expected return on plan assets used was 7.25%, 7.75% and 7.75% for the years ended December 31, 2012, 2011, and 2010, respectively. The rate of compensation increase used varied from 2.94% to 4.17% for the year ended December 31, 2012, 2.99% to 4.35% for the year ended December 31, 2011, and 3.21% to 4.53% for the year ended 2010, depending on the plan and the related work group.

In determining the discount rate used, the Company’s policy is to use the rates at the end of the year on high-quality long-term bonds with maturities that closely match the expected timing of future cash distributions from the plan. In determining the expected return on plan assets, the Company assesses the current level of expected returns on risk-free investments (primarily government bonds), the historical level of the risk premium associated with the other asset classes in which the portfolio is invested and the expectations for future returns of each asset class. The expected return for each asset class is then weighted based on the target asset allocation to develop the expected long-term rate of return on assets assumption for the portfolio.

Plan assets are invested in common commingled trust funds invested in equity and fixed income securities. The asset allocation of the funds in the qualified defined-benefit plans, by asset category, is as follows as of December 31:



	2012		2011
Asset category:
Money market fund	5	%	1	%
Domestic equity securities	43	%	45	%
Non-U.S. equity securities	20	%	20	%
Fixed income securities	32	%	34	%
Plan assets	100	%	100	%

The Company’s investment policy focuses on achieving maximum returns at a reasonable risk for pension assets over a full market cycle. The Company uses a fund manager and invests in various asset classes to diversify risk. Target allocations for the primary asset classes are approximately:



Domestic equities:	37% - 52%
Non-U.S. equities:	15% - 25%
Fixed income:	30% - 42%

Pension assets are rebalanced periodically to maintain these target asset allocations. An individual equity investment will not exceed 10% of the entire equity portfolio. Fixed-income securities carry a minimum “A” rating by Moody’s and/or Standard and Poor’s and the average life of the bond portfolio may not exceed ten years. The Company does not currently intend to invest plan assets in the Company’s common stock.

As of December 31, 2012, other than the money market fund, all assets were invested in common commingled trust funds. The Company uses the net asset values of these funds to determine fair value as allowed using the practical expediency method outlined in the accounting standards. Plan asset by fund category and fair value hierarchy level as of December 31 (dollars in millions):



	2012		2011		Level
Fund type:
Money market fund	$	75	$	12	1
U.S. equity market fund	654		579		2
Non-U.S. equity fund	304		256		2
Credit bond index fund	102		—		2
U.S. debt index fund	—		75		2
Government/credit bond index fund	403		366		2
Plan assets	$	1,538	$	1,288

Nonqualified Defined-Benefit Pension Plan

Alaska also maintains an unfunded, noncontributory defined-benefit plan for certain elected officers. This plan uses a December 31 measurement date.

Weighted average assumptions used to determine benefit obligations as of December 31:

Discount rates of 3.95% and 4.65% were used as of December 31, 2012 and 2011, respectively. The rate of compensation increase used was 5.00% as of December 31, 2012 and 2011.

Weighted average assumptions used to determine net periodic benefit cost for the years ended December 31:

Discount rates of 4.65%, 5.55%, and 5.85% were used for the years ended December 31, 2012, 2011, and 2010, respectively. The rate of compensation increase used was 7.00% per year during the first four years of employment and 5.00% thereafter for the year ended December 31, 2012. The rate of compensation increase used was 5.00% for the years ended December 31, 2011 and 2010.

Combined Disclosures for Defined-Benefit Pension Plans

The following table sets forth the status of the plans as of December 31 (in millions):



	Qualified						Nonqualified
	2012			2011			2012			2011
Projected benefit obligation (PBO)
Beginning of year	$	1,594		$	1,343		$	43		$	41
Service cost	38			35			1			1
Interest cost	73			73			2			2
Plan amendments	—			(21		)	—			1
Actuarial (gain) loss	214			206			(2		)	3
Benefits paid	(46		)	(42		)	(2		)	(5		)
End of year	$	1,873		$	1,594		$	42		$	43

Plan assets at fair value
Beginning of year	$	1,288		$	1,143		$	—		$	—
Actual return on plan assets	186			54			—			—
Employer contributions	110			133			2			5
Benefits paid	(46		)	(42		)	(2		)	(5		)
End of year	$	1,538		$	1,288		$	—		$	—
Funded status (unfunded)	$	(335	)	$	(306	)	$	(42	)	$	(43	)

Percent funded	82		%	81		%	—			—

The accumulated benefit obligation for the combined qualified defined-benefit pension plans was $1,733 million and $1,483 million at December 31, 2012 and 2011, respectively. The accumulated benefit obligation for the nonqualified defined-benefit plan was $41 million and $42 million at December 31, 2012 and 2011, respectively.

As of December 31, 2012 and 2011, the amounts recognized in the consolidated balance sheets were as follows (in millions):



	2012				2011
	Qualified		Nonqualified		Qualified		Nonqualified
Accrued benefit liability-current	$	—	$	2	$	—	$	2
Accrued benefit liability-long term	335		40		306		41
Total liability recognized	$	335	$	42	$	306	$	43

AMOUNTS NOT YET REFLECTED IN NET PERIODIC BENEFIT COST AND INCLUDED IN AOCL:



	2012					2011
	Qualified			Nonqualified		Qualified			Nonqualified
Prior service credit	$	(15	)	$	—	$	(15	)	$	—
Net loss	695			9		613			12
Amount recognized in AOCL (pretax)	$	680		$	9	$	598		$	12

The expected amortization of prior service credit and net loss from AOCL in 2013 is $1 million and $43 million, respectively, for the qualified defined-benefit pension plans. For the nonqualified defined-benefit pension plans, the expected combined amortization of prior service cost and net loss from AOCL in 2013 is $1 million.

Net pension expense for the defined-benefit plans included the following components for the years ended December 31 (in millions):



	Qualified									Nonqualified
	2012			2011			2010			2012		2011		2010
Service cost	$	38		$	35		$	32		$	1	$	1	$	1
Interest cost	73			73			68			2		2		2
Expected return on assets	(93		)	(88		)	(71		)	—		—		—
Amortization of prior service cost	(1		)	(1		)	(1		)	—		—		—
Recognized actuarial loss	40			23			22			1		1		—
Net pension expense	$	57		$	42		$	50		$	4	$	4	$	3

Historically, the Company’s practice has been to contribute to the qualified defined-benefit pension plans in an amount equal to the greater of 1) the minimum required by law, 2) the Pension Protection Act (PPA) target liability, or 3) the service cost as actuarially calculated. There are no current funding requirements for the Company’s plans in 2013. However, the funding in 2013 is estimated to be $35 million to $50 million. The Company expects to contribute approximately $2 million to the nonqualified defined-benefit pension plans during 2013.

Future benefits expected to be paid over the next ten years under the defined-benefit pension plans from the assets of those plans as of December 31, 2012 (in millions):



	Qualified		Nonqualified
2013	$	60	$	2
2014	75		3
2015	78		3
2016	79		5
2017	95		3
2018 - 2022	532		23

Postretirement Medical Benefits

The Company allows retirees to continue their medical, dental, and vision benefits by paying all or a portion of the active employee plan premium until eligible for Medicare, currently age 65. This results in a subsidy to retirees, because the premiums received by the Company are less than the actual cost of the retirees’ claims. The accumulated postretirement benefit obligation (APBO) for this subsidy is unfunded. This liability was determined using an assumed discount rate of 3.95% and 4.65% at December 31, 2012 and 2011, respectively. The Company does not believe the U.S. Health Care Reform: The Patient Protection and Affordable Care Act and The Health Care and Education Reconciliation Act will have a significant impact on the Company's cost for postretirement medical benefits.



(in millions)	2012			2011
Accumulated postretirement benefit obligation
Beginning of year	$	120		$	133
Service cost	5			6
Interest cost	5			7
Actuarial gain	(11		)	(23		)
Benefits paid	(2		)	(3		)
End of year	$	117		$	120

Plan assets at fair value
Beginning of year	$	—		$	—
Employer contributions	2			3
Benefits paid	(2		)	(3		)
End of year	$	—		$	—
Funded status (unfunded)	$	(117	)	$	(120	)

As of December 31, 2012 and 2011, the amounts recognized in the consolidated balance sheets (in millions):



	2012		2011
Accrued benefit liability-current	$	4	$	4
Accrued benefit liability-long term	113		116
Total liability recognized	$	117	$	120

AMOUNTS NOT YET REFLECTED IN NET PERIODIC BENEFIT COST AND INCLUDED IN AOCL:



(in millions)	2012			2011
Prior service cost	$	2		$	2
Net gain	(15		)	(4		)
Amount recognized in AOCL (pretax)	$	(13	)	$	(2	)

The Company uses a December 31 measurement date to assess obligations associated with the subsidy of retiree medical costs. Net periodic benefit cost for the postretirement medical plans included the following components for the years ended December 31 (in millions):



	2012			2011		2010
Service cost	$	5		$	6	$	5
Interest cost	5			7		7
Amortization of prior service cost	1			1		—
Recognized actuarial (gain) loss	(1		)	1		—
Net periodic benefit cost	$	10		$	15	$	12

This is an unfunded plan. The Company expects to contribute approximately $4 million to the postretirement medical benefits plan in 2013, which is equal to the expected benefit payments.

Future benefits expected to be paid over the next ten years under the postretirement medical benefits plan as of December 31, 2012 (in millions):



2013	$	4
2014	5
2015	5
2016	6
2017	7
2018– 2022	43

The assumed health care cost trend rates to determine the expected 2013 benefits cost are 8.3%, 8.3%, 5.0% and 4.0% for medical, prescription drugs, dental and vision costs, respectively. The assumed trend rate declines steadily through 2028 where the ultimate assumed trend rates are 4.7% for medical, prescription drugs and dental, and 4.0% for vision.

A 1% higher or lower trend rate in health care costs has the following effect on the Company’s postretirement medical plans for the years ended December 31 (in millions):



	2012			2011			2010
Change in service and interest cost
1% higher trend rate	$	2		$	2		$	2
1% lower trend rate	(1		)	(2		)	(2		)
Change in year-end postretirement benefit obligation
1% higher trend rate	$	14		$	14		$	16
1% lower trend rate	(12		)	(13		)	(14		)

Defined-Contribution Plans

The defined-contribution plans are deferred compensation plans under section 401(k) of the Internal Revenue Code. All of these plans require Company contributions. Total expense for the defined-contribution plans was $43 million, $42 million, and $40 million in 2012, 2011, and 2010, respectively.

The Company also has a noncontributory, unfunded defined-contribution plan for certain elected officers of the Company who are ineligible for the nonqualified defined-benefit pension plan. Amounts recorded as liabilities under the plan are not material to the consolidated balance sheet at December 31, 2012 and 2011.

Pilot Long-term Disability Benefits

Alaska maintains a long-term disability plan for its pilots. The long-term disability plan does not have a service requirement. Therefore, the liability is calculated based on estimated future benefit payments associated with pilots that were assumed to be disabled on a long-term basis as of December 31, 2012 and does not include any assumptions for future disability. The liability includes the discounted expected future benefit payments and medical costs. The total liability was $11 million and $8 million, which was recorded net of a prefunded trust account of $1 million and $1 million, and included in long-term other liabilities on the consolidated balance sheets as of December 31, 2012 and 2011, respectively.

Employee Incentive-Pay Plans

Alaska and Horizon have employee incentive plans that pay employees based on certain financial and operational metrics. The aggregate expense under these plans in 2012, 2011 and 2010 was $88 million, $72 million, and $92 million, respectively. The plans are summarized below:


•	Performance-Based Pay (PBP) is a program that rewards all employees. The program is based on four separate metrics related to Air Group profitability, safety, achievement of unit-cost goals, and employee engagement as measured by customer satisfaction.


•	The Operational Performance Rewards Program entitles all Air Group employees to quarterly payouts of up to $300 per person if certain operational and customer service objectives are met.