WALGREENS BOOTS ALLIANCE, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS
15. Retirement Benefits
The Company sponsors several retirement plans, including defined benefit plans, defined contribution plans and a postretirement health plan. Pursuant to the Second Step Transaction, the Company assumed a number of retirement benefit plans in the United Kingdom and other countries. The Company valued the assumed pension assets and liabilities on the acquisition date and uses an August 31 annual measurement date for its pension and post-retirement plans.
Effective September 1, 2016, for UK and U.S. benefit plans using the yield curve approach, the Company will change the method used to calculate the service cost and interest cost components of net periodic benefit costs for pension and postretirement benefit plans and will measure these costs by applying the specific spot rates along the yield curve to the plans’ projected cash flows. The Company believes the new approach will provide a more precise measurement of service and interest costs by improving the correlation between projected cash flows and the corresponding spot yield curve rates. The change does not affect the measurement of the Company’s pension and other postretirement benefit obligations for those plans and will be accounted for as a change in accounting estimate, which is applied prospectively. This change is not expected to have a material impact to the 2017 full year results.
Defined Benefit Pension Plans (non-U.S. plans)
The principal defined benefit pension plan is the Boots Pension Plan covering certain employees in the United Kingdom (the “Boots Plan”). The Boots Plan is a funded final salary defined benefit plan providing pensions and death benefits to members. The Boots Plan was closed to future accrual effective July 1, 2010 with pensions calculated based on salaries up until that date. The Boots Plan is governed by a trustee board, which is independent of the Company. The plan is subject to a full funding actuarial valuation on a triennial basis. The Company also has two smaller defined benefit plans in the United Kingdom, both of which were closed to future accruals effective July 1, 2010.
Defined benefit pension plan assets were invested in the following classes of securities as of August 31:
Percentage of Fair Market Value 2016 2015
Equity securities 8.9% 9.5%
Debt securities 78.8% 81.5%
Real estate 4.3% 5.6%
Other 8.0% 3.4%
The investment strategy of the principal defined benefit pension plan is to hold approximately 85% of its assets in a diverse portfolio of high quality bonds with the remainder invested in equity and real estate assets backing longer term liabilities. Interest rate and inflation rate swaps are also employed to complement the role of fixed and index-linked bond holdings in liability risk management.
The following table presents defined benefit pension plan assets using the fair value hierarchy as of August 31, 2016 (in millions).
August 31, 2016 Level 1 Level 2 Level 3
Equity securities:
Equity securities(1) $ 834 $— $ 834 $—
Debt securities:
Fixed interest government bonds(2) 265 — 265 —
Index linked government bonds(2) 3,502 — 3,502 —
Corporate bonds(3) 3,663 — 3,663 —
Real estate:
Real estate(4) 411 — — 411
Other:
Other investments(5) 753 38 713 2
Total $9,428 $ 38 $8,977 $413
August 31, 2015 Level 1 Level 2 Level 3
Equity securities:
Equity securities(1) $ 852 $— $ 852 $—
Debt securities:
Fixed interest government bonds(2) 267 — 267 —
Index linked government bonds(2) 1,006 — 1,006 —
Corporate bonds(3) 5,535 — 5,535 —
Other bonds(6) 472 — 472 —
Real estate:
Real estate(4) 502 — — 502
Other:
Other investments(5) 302 25 275 2
Total $8,936 $ 25 $8,407 $504
(1) Equity securities, which mainly comprise investments in comingled funds, are valued based on quoted prices and are primarily exchange-traded. Securities for which official close or last trade pricing on an active exchange is available are classified as Level 1 investments. If closing prices are not available, securities are valued at the last quoted bid price and typically are categorized as Level 2 investments.
(2) Debt securities: government bonds comprise fixed interest and index linked bonds issued by central governments, and are valued based on quotes received from independent pricing services or from dealers who make markets in such securities. Pricing services utilize pricing which considers readily available inputs such as the yield or price of bonds of comparable quality, coupon, maturity, and type, as well as dealer-supplied prices. Debt securities: government bonds are categorized as Level 2 investments.
(3) Debt securities: corporate bonds comprise bonds issued by corporations and are valued using recently executed transactions, or quoted market prices for similar assets and liabilities in active markets, or for identical assets and liabilities in markets that are not active. If there have been no market transactions in a particular fixed income security, its fair value is calculated by pricing models that benchmark the security against other securities with actual market prices. Debt securities: corporate bonds are categorized as Level 2 investments.
(4) Real estate comprises investments in certain property funds which themselves are valued based on the value of the underlying properties. These properties are valued using a number of standard industry techniques
such as cost, discounted cash flows, independent appraisals and market based comparable data. Real estate investments are categorized as Level 3 investments. Change in Level 3 investments driven primarily by currency fluctuations.
(5) Other investments mainly comprise cash and cash equivalents and derivatives. Cash is categorized as a Level 1 investment. Cash equivalents are valued using observable yield curves, discounting and interest rates and are categorized as Level 2 investments. Derivatives which are exchange-traded and for which market quotations are readily available are valued at the last reported sale price or official closing price as reported by an independent pricing service on the primary market, or exchange on which they are traded, and are categorized as Level 1 investments. Over-the-counter derivatives typically are valued by
independent pricing services and are categorized as Level 2 investments.
(6) Debt securities: other bonds comprise agency and mortgage-backed securities. These are valued using recently executed transactions and quoted market prices for similar assets and liabilities in active markets, or for identical assets and liabilities in markets that are not active. If there have been no market transactions in a particular fixed income security, its fair value is calculated by pricing models that benchmark the security against other securities with actual market prices. Debt securities: other bonds are categorized as Level 2 investments.
Components of net periodic pension costs for the defined benefit pension plans (in millions):
Boots and Other Pension Plans 2016 2015(1)
Service costs $ 4 $ 3
Interest costs 308 214
Expected returns on plan assets (247) (173)
Curtailments (2) (2)
Total net periodic pension costs $ 63 $ 42
Change in benefit obligations for the defined benefit pension plans (in millions):
2016 2015(1)
Benefit obligation at beginning of year $ 8,635 $8,827
Service costs 4 3
Interest costs 308 214
Amendments (2) (2)
Net actuarial (gain) loss 2,272 (103)
Benefits paid (277) (186)
Currency translation adjustments (1,477) (118)
Benefit obligation at end of year $ 9,463 $8,635 Change in plan assets for the defined benefit pension plans (in millions):
2016 2015(1)
Plan assets at fair value at beginning of year $ 8,936 $8,987
Employer contributions 75 152
Benefits paid (277) (186)
Return on assets 2,216 91
Currency translation adjustments (1,522) (108)
Plan assets at fair value at end of year $ 9,428 $8,936
Amounts recognized in the Consolidated Balance Sheets (in millions):
2016 2015
Other non-current assets $ 155 $ 468
Accrued expenses and other liabilities (6) (1)
Other non-current liabilities (184) (166)
Net (liability) asset recognized at end of year $ (35) $ 301 Pre-tax amounts recognized in accumulated other comprehensive (income) loss (in millions):
2016 2015(1)
Net actuarial (gain) loss $(258) $21
(1) Fiscal 2015 represents change in pension benefit obligation and plan assets from December 31, 2014 to August 31, 2015.
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for all pension plans including accumulated benefit obligations in excess of plan assets at August 31, 2016 were as follows (in millions):
2016 2015
Projected benefit obligation $9,463 $8,635
Accumulated benefit obligation 9,457 8,624
Fair value of plan assets 9,428 8,936
Estimated future benefit payments from defined benefit pension plans to participants are as follows (in millions):
Estimated Future Benefit Payments
2017 $ 264
2018 237
2019 248
2020 266
2021 279
2022-2026 1,641
The assumptions used in accounting for the defined benefit pension plans were as follows:
2016 2015
Weighted-average assumptions used to determine benefit obligations
Discount rate 2.17% 3.87%
Rate of compensation increase 2.44% 2.55%
Weighted-average assumptions used to determine net periodic benefit cost
Discount rate 3.87% 3.77%
Expected long-term return on plan assets 3.05% 2.99%
Rate of compensation increase 2.55% 2.66%
Based on current actuarial estimates, the Company plans to make contributions of $66 million to its defined benefit pension plans in fiscal 2017 and expects to make contributions beyond 2017, which will vary based upon many factors, including the performance of the Company’s pension investments.
Defined Contribution Plans
The principal retirement plan for U.S. employees is the Walgreen Profit-Sharing Retirement Trust, to which both the Company and participating employees contribute. The Company’s contribution, which has historically related to adjusted FIFO earnings before interest and taxes and a portion of which is in the form of a guaranteed match, is determined annually at the discretion of the Board of Directors. The profit-sharing provision was an expense of
$226 million, $158 million and $355 million in fiscal 2016, 2015 and 2014, respectively. The Company’s contributions were $225 million, $249 million and $328 million in fiscal 2015, 2014 and 2013, respectively.
The Company also has certain contract based defined contribution arrangements. The principal one is the Alliance Healthcare & Boots Retirement Savings Plan, which is United Kingdom based and to which both the Company and participating employees contribute. The cost related to these arrangements recognized in the Consolidated Statement of Earnings for fiscal 2016 was $130 million and from the date of the Second Step Transaction through August 31, 2015 was $93 million.
Postretirement Healthcare Plan
The Company provides certain health insurance benefits to retired U.S. employees who meet eligibility requirements, including age, years of service and date of hire. The costs of these benefits are accrued over the service life of the employee. The Company’s postretirement health benefit plan obligation was $466 and $431 million in fiscal 2016 and 2015 respectively and is not funded. The expected benefit to be paid net of the estimated federal subsidy during fiscal year 2017 is $11 million.