NOTE 8. 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 consolidated 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:



	2014	2013
Discount rate	4.20%	4.85%
Rate of compensation increases^(a)	2.85% to 3.91%	2.90% to 3.93%


^(a)	Varies by plan and related work group.

Weighted average assumptions used to determine net periodic benefit cost:



	2014	2013	2012
Discount rate	4.85%	3.95%	4.65%
Expected return on plan assets	6.75%	7.25%	7.25%
Rate of compensation increases^(a)	2.90% to 3.93%	3.05% to 4.02%	2.94% to 4.17%


^(a)	Varies by plan and related work group.

The discount rate was determined using current rates earned on high-quality, long-term bonds with maturities that correspond with the estimated cash distributions from the pension plans. At December 31, 2014, the Company selected a discount rate using a pool of higher-yielding bonds estimated to be more reflective of settlement rates, as management has taken steps to ultimately terminate or settle plans that are frozen and move toward freezing benefits in active plans in the future. 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:



	2014		2013
Asset category:
Money market fund	—	%	3	%
Domestic equity securities	33	%	39	%
Non-U.S. equity securities	14	%	17	%
Fixed income securities	53	%	41	%
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 based on current funded status are approximately:



Domestic equities:	27% - 38%
Non-U.S. equities:	11% - 19%
Fixed income:	48% - 58%

The Company determines the strategic allocation between equity and fixed income based on current funded status and other characteristics of the plan. As the funded status improves, the Company increases the fixed income allocation of the portfolio, and decreases the equity allocation. Actual asset allocations are reviewed regularly and periodically rebalanced as appropriate.

As of December 31, 2014, 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 (in millions):



	2014		2013		Level
Fund type:
Money market fund	$	—	$	45	1
U.S. equity market fund	634		684		2
Non-U.S. equity fund	272		301		2
Credit bond index fund	190		127		2
Government/credit bond index fund	821		612		2
Plan assets	$	1,917	$	1,769

The following table sets forth the status of the qualified defined-benefit pension plans (in millions):



	2014			2013
Projected benefit obligation (PBO)
Beginning of year	$	1,709		$	1,873
Service cost	33			46
Interest cost	81			73
Plan settlement	—			—
Actuarial (gain) loss	298			(226		)
Benefits paid	(71		)	(57		)
End of year	$	2,050		$	1,709

Plan assets at fair value
Beginning of year	$	1,769		$	1,538
Actual return on plan assets	219			205
Employer contributions	—			83
Plan settlements	—			—
Benefits paid	(71		)	(57		)
End of year	$	1,917		$	1,769
Funded status (unfunded)	$	(133	)	$	60

Percent funded	94		%	104		%

The accumulated benefit obligation for the combined qualified defined-benefit pension was $1.9 billion and $1.6 billion at December 31, 2014, and 2013, respectively.

The amounts recognized in the consolidated balance sheets (in millions):



	2014		2013
Plan assets-long term (within long term Other Assets)	$	—	$	60
Accrued benefit liability-long term	133		—
Total liability recognized	$	133	$	—

The amounts not yet reflected in net periodic benefit cost and included in AOCL:



	2014			2013
Prior service credit	$	(12	)	$	(14	)
Net loss	514			331
Amount recognized in AOCL (pretax)	$	502		$	317

The expected amortization of prior service credit and net loss from AOCL in 2015 is $1 million and $26 million, respectively, for the qualified defined-benefit pension plans.

Net pension expense for the qualified defined-benefit plans included the following components (in millions):



	2014			2013			2012
Service cost	$	33		$	46		$	38
Interest cost	81			73			73
Expected return on assets	(117		)	(111		)	(93		)
Amortization of prior service cost	(1		)	(1		)	(1		)
Recognized actuarial loss	13			43			40
Net pension expense	$	9		$	50		$	57

Historically, the Company’s practice has been to contribute to the qualified defined-benefit pension plans 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 2015. The Company expects to contribute between $30 million and $35 million to the qualified defined-benefit pension plans during 2015. The Company expects to contribute approximately $4 million to the nonqualified defined-benefit pension plans during 2015.

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



2015	$	78
2016	86
2017	93
2018	93
2019	104
2020 - 2024	600

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. The assumptions used to determine benefit obligations and the net period benefit cost for the nonqualified defined-benefit pension plan are similar to those used to calculate the qualified defined-benefit pension plan. The plan's unfunded status, PBO, accumulated benefit obligation is immaterial. The net pension expense in prior year and expected future expense is also immaterial.

Postretirement Medical Benefits

The Company allows certain 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 4.20% and 4.85% at December 31, 2014 and 2013, 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.

During 2014, the Company made changes to the postretirement medical benefits for non-union personnel and certain labor groups to sunset the postretirement medical benefits beginning in 2015. As a result of these changes, the Company recognized a partial curtailment gain of $25 million during December 31, 2014. The curtailment gain included $5 million associated with an embedded sick leave subsidy. This subsidy was used to establish a new compensated absence liability. The net impact of the curtailment gain of $20 million is included in special items in the income statement.



(in millions)	2014			2013
Accumulated postretirement benefit obligation
Beginning of year	$	89		$	117
Service cost	3			5
Interest cost	4			4
Curtailment gain	(25		)	—
Actuarial loss (gain)	12			(35		)
Benefits paid	(2		)	(2		)
End of year	$	81		$	89

Plan assets at fair value
Beginning of year	$	—		$	—
Employer contributions	2			2
Benefits paid	(2		)	(2		)
End of year	$	—		$	—
Funded status (unfunded)	$	(81	)	$	(89	)

The amounts recognized in the consolidated balance sheets (in millions):



	2014		2013
Accrued benefit liability-current	$	4	$	3
Accrued benefit liability-long term	77		86
Total liability recognized	$	81	$	89

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



(in millions)	2014			2013
Prior service cost	$	—		$	1
Net gain	(32		)	(48		)
Amount recognized in AOCL (pretax)	$	(32	)	$	(47	)

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 (in millions):



	2014			2013			2012
Service cost	$	3		$	5		$	5
Interest cost	4			4			5
Amortization of prior service cost	1			1			1
Recognized actuarial (gain) loss	(3		)	(2		)	(1		)
Curtailment gain	(25		)	—			—
Net periodic benefit (gain) cost	$	(20	)	$	8		$	10

This is an unfunded plan. The Company expects to contribute approximately $4 million to the postretirement medical benefits plan in 2015, 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 (in millions):



2015	$	4
2016	4
2017	5
2018	5
2019	5
2020 - 2024	28

The assumed health care cost trend rates to determine the expected 2015 benefits cost are 7.7%, 7.7%, 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 (in millions):



	2014			2013			2012
Change in service and interest cost
1% higher trend rate	$	1		$	1		$	2
1% lower trend rate	(1		)	(1		)	(1		)
Change in year-end postretirement benefit obligation
1% higher trend rate	$	9		$	10		$	14
1% lower trend rate	(8		)	(9		)	(12		)

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 $54 million, $44 million, and $43 million in 2014, 2013, and 2012, 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, 2014 and 2013.

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, 2014 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 $16 million and $12 million, which was recorded net of a prefunded trust account of $2 million and $1 million, and included in long-term other liabilities on the consolidated balance sheets as of December 31, 2014 and December 31, 2013, respectively.

Employee Incentive-Pay Plans

Alaska and Horizon have employee incentive plans that pay employees based on certain financial and operational metrics. These metrics are set and approved annually by the Compensation Committee of the Board of Directors. The aggregate expense under these plans in 2014, 2013 and 2012 was $116 million, $105 million, and $88 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.