NOTE 7. 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:



	2015	2014
Discount rates ^(a)	4.55% to 4.69%	4.20%
Rate of compensation increases^(a)	2.06% to 2.65%	2.85% to 3.91%


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

Weighted average assumptions used to determine net periodic benefit cost:



	2015	2014	2013
Discount rate	4.20%	4.85%	3.95%
Expected return on plan assets	6.50%	6.75%	7.25%
Rate of compensation increases^(a)	2.85% to 3.91%	2.90% to 3.93%	3.05% to 4.02%


^(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, 2015, the Company selected discount rates for each of the plans 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 and in certain real estate assets. The asset allocation of the funds in the qualified defined-benefit plans, by asset category, is as follows:



	2015		2014
Asset category:
Domestic equity securities	28	%	33	%
Non-U.S. equity securities	12	%	14	%
Fixed income securities	55	%	53	%
Real estate	5	%	—	%
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. In 2015, the Company separated the management of plan assets for the defined-benefit plan that covers the Company's non-union, management participants. This plan has been closed to new participants for several years and benefits were frozen effective January 1, 2014. These assets have a higher allocation to fixed income securities than the other plans. 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:	21% - 33%
Non-U.S. equities:	7% - 17%
Fixed income:	48% - 67%
Real estate:	0% - 8%

The Company determines the strategic allocation between equities, fixed income, and real estate based on current funded status and other characteristics of the plans. 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, 2015, all assets other than real estate 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. Fair value estimates for real estate are calculated using the present value of expected future cash flows based on independent appraisals, local market conditions, and current and projected operating performance.

Plan asset by fund category (in millions):



	2015		2014		Fair Value Hierarchy
Fund type:
U.S. equity market fund	491		634		^(a)
Non-U.S. equity fund	208		272		^(a)
Credit bond index fund	953		190		^(a)
Government/credit bond index fund	—		821		^(a)
Plan assets in common commingled trusts	$	1,652	$	1,917
Real estate	85		—		Level 3
Total plan assets	$	1,737	$	1,917

^(a) In accordance with Subtopic 820-10, certain investments that are measured at fair value using the net asset value per share practical expedient have not been classified in the fair value hierarchy.

Changes in our Level 3 plan assets for the year ended December 31, 2015 included:



Asset Category	December 31, 2014 Balance		Net Realized and Unrealized Gains/Losses	Net Purchases, Issuances and Settlements	Net Transfers Into/(Out of) Level 3	December 31, 2015 Balance
Real Estate	$	—	5	80	—	$	85

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



	2015			2014
Projected benefit obligation (PBO)
Beginning of year	$	2,050		$	1,709
Service cost	41			33
Interest cost	84			81
Plan settlement	(62		)	—
Actuarial (gain) loss	(140		)	298
Benefits paid	(75		)	(71		)
End of year	$	1,898		$	2,050

Plan assets at fair value
Beginning of year	$	1,917		$	1,769
Actual return on plan assets	(43		)	219
Employer contributions	—			—
Plan settlement	(62		)	—
Benefits paid	(75		)	(71		)
End of year	$	1,737		$	1,917
Funded status (unfunded)	$	(161	)	$	(133	)

Percent funded	92		%	94		%

The accumulated benefit obligation for the combined qualified defined-benefit pension was $1.8 billion and $1.9 billion at December 31, 2015, and 2014, respectively.

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



	2015			2014
Accrued benefit liability-long term	$	173		$	133
Plan assets-long term (within noncurrent Other Assets)	(12		)	—
Total liability recognized	$	161		$	133

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



	2015			2014
Prior service credit	$	(11	)	$	(12	)
Net loss	499			514
Amount recognized in AOCL (pretax)	$	488		$	502

The expected amortization of prior service credit and net loss from AOCL in 2016 is $(1) million and $25 million, respectively, for the qualified defined-benefit pension plans.

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



	2015			2014			2013
Service cost	$	41		$	33		$	46
Interest cost	84			81			73
Expected return on assets	(122		)	(117		)	(111		)
Amortization of prior service cost	(1		)	(1		)	(1		)
Recognized actuarial loss	26			13			43
Settlement expense (special item)	14			—			—
Net pension expense	$	42		$	9		$	50

In 2015, the Company recognized a settlement charge of $14 million related to lump sum settlements offered to terminated, vested plan participants. The result was a reduction in the projected benefit obligation of $62 million. The settlement charge reflects the remaining unamortized actuarial loss in AOCL associated with the settled obligation.

There are no current statutory funding requirements for the Company’s plans in 2016, nor does the Company expect to contribute to the qualified defined-benefit pension plans during 2016.

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):



2016	$	77
2017	86
2018	93
2019	96
2020	107
2021 - 2024	613

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. The accumulated postretirement benefit obligation was $64 million and $81 million at December 31, 2015 and 2014, respectively. The net periodic benefit cost was not material to the statement of operations.

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 effective in 2015. As a result of these changes, the Company recognized a partial curtailment gain of $25 million in 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.

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 $60 million, $54 million, and $44 million in 2015, 2014, and 2013, 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, 2015 and 2014.

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, 2015 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 $19 million and $16 million, which was recorded net of a prefunded trust account of $2 million and $2 million, and included in long-term other liabilities on the consolidated balance sheets as of December 31, 2015 and December 31, 2014, 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 2015, 2014 and 2013 was $120 million, $116 million, and $105 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.