Merck & Co. Inc. | 2013 | FY | 3


Pension and Other Postretirement Benefit Plans
The Company has defined benefit pension plans covering eligible employees in the United States and in certain of its international subsidiaries. As a result of plan design changes approved in 2011, beginning on January 1, 2013, active participants in Merck’s primary U.S. defined benefit pension plans are accruing pension benefits using new cash balance formulas based on age, service, pay and interest. However, during a transition period from January 1, 2013 through December 31, 2019, participants will earn the greater of the benefit as calculated under the employee’s legacy final average pay formula or their new cash balance formula. For all years of service after December 31, 2019, participants will earn future benefits under only the cash balance formula. In addition, the Company provides medical benefits, principally to its eligible U.S. retirees and their dependents, through its other postretirement benefit plans. The Company uses December 31 as the year-end measurement date for all of its pension plans and other postretirement benefit plans.

Net Periodic Benefit Cost
The net periodic benefit cost for pension and other postretirement benefit plans consisted of the following components:
 
Pension Benefits
 
Other Postretirement Benefits
Years Ended December 31
2013
 
2012
 
2011
 
2013
 
2012
 
2011
Service cost
$
682

 
$
555

 
$
619

 
$
102

 
$
82

 
$
110

Interest cost
665

 
661

 
718

 
107

 
121

 
141

Expected return on plan assets
(1,097
)
 
(970
)
 
(972
)
 
(126
)
 
(136
)
 
(142
)
Net amortization
336

 
185

 
201

 
(50
)
 
(35
)
 
(17
)
Termination benefits
58

 
27

 
59

 
50

 
18

 
29

Curtailments
(23
)
 
(10
)
 
(86
)
 
(11
)
 
(7
)
 
1

Settlements
23

 
18

 
4

 

 

 

Net periodic benefit cost
$
644

 
$
466

 
$
543

 
$
72

 
$
43

 
$
122


The increase in net periodic benefit cost for pension and other postretirement benefit plans in 2013 as compared with 2012 is largely attributable to a change in the discount rate. The net periodic benefit cost attributable to U.S. pension plans included in the above table was $348 million in 2013, $268 million in 2012 and $406 million in 2011.
In connection with restructuring actions (see Note 3), termination charges were recorded in 2013, 2012 and 2011 on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring activities, curtailments were recorded in 2013, 2012 and 2011 on pension and other postretirement benefit plans.
In addition, settlements were recorded in 2013, 2012 and 2011 on certain domestic and international pension plans.

Obligations and Funded Status
Summarized information about the changes in plan assets and benefit obligation, the funded status and the amounts recorded at December 31 is as follows:
 
Pension Benefits
 
Other
Postretirement
Benefits
  
2013
 
2012
 
2013
 
2012
Fair value of plan assets January 1
$
15,349

 
$
12,481

 
$
1,760

 
$
1,628

Actual return on plan assets
2,524

 
1,739

 
199

 
200

Company contributions
645

 
1,853

 
73

 
48

Effects of exchange rate changes
(84
)
 
3

 

 

Benefits paid
(780
)
 
(673
)
 
(119
)
 
(115
)
Settlements
(236
)
 
(75
)
 

 

Other
17

 
21

 

 
(1
)
Fair value of plan assets December 31
$
17,435

 
$
15,349

 
$
1,913

 
$
1,760

Benefit obligation January 1
17,646

 
14,416

 
2,650

 
2,529

Service cost
682

 
555

 
102

 
82

Interest cost
665

 
661

 
107

 
121

Actuarial (gains) losses
(1,689
)
 
2,660

 
(428
)
 
88

Benefits paid
(780
)
 
(673
)
 
(119
)
 
(115
)
Effects of exchange rate changes
(21
)
 
67

 
(5
)
 

Plan amendments
(225
)
 
2

 
(38
)
 
(86
)
Curtailments
(61
)
 
(17
)
 

 
1

Termination benefits
58

 
27

 
50

 
18

Settlements
(236
)
 
(75
)
 

 

Other
16

 
23

 
10

 
12

Benefit obligation December 31
$
16,055

 
$
17,646

 
$
2,329

 
$
2,650

Funded status December 31
$
1,380

 
$
(2,297
)
 
$
(416
)
 
$
(890
)
Recognized as:
 
 
 
 
 
 
 
Other assets
$
2,811

 
$
355

 
$

 
$
506

Accrued and other current liabilities
(53
)
 
(50
)
 
(8
)
 
(9
)
Other noncurrent liabilities
(1,378
)
 
(2,602
)
 
(408
)
 
(1,387
)

The fair value of U.S. pension plan assets included in the preceding table was $10.0 billion and $8.7 billion at December 31, 2013 and 2012, respectively, and the projected benefit obligation of U.S. pension plans was $8.7 billion and $10.0 billion, respectively. Approximately 46% and 44% of the Company’s pension projected benefit obligation at December 31, 2013 and 2012, respectively, relates to international defined benefit plans, of which each individual plan is not significant relative to the total projected benefit obligation.
At December 31, 2013 and 2012, the accumulated benefit obligation was $14.8 billion and $15.9 billion, respectively, for all pension plans, of which $8.0 billion and $9.0 billion, respectively, related to U.S. pension plans.
For pension plans with projected benefit obligations in excess of plan assets at December 31, 2013 and 2012, the fair value of plan assets was $1.5 billion and $12.8 billion, respectively, and the benefit obligations were $3.0 billion and $15.5 billion, respectively. For those plans with accumulated benefit obligations in excess of plan assets at December 31, 2013 and 2012, the fair value of plan assets was $1.4 billion and $6.1 billion, respectively, and the accumulated benefit obligations were $2.5 billion and $7.7 billion, respectively.
Plan Assets
Entities are required to use a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest:
Level 1 —  Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 —  Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 —  Unobservable inputs that are supported by little or no market activity. The Level 3 assets are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as instruments for which the determination of fair value requires significant judgment or estimation. At December 31, 2013 and 2012, $622 million and $692 million, respectively, or approximately 4% and 5%, respectively, of the Company’s pension investments at each year end, were categorized as Level 3 assets.
If the inputs used to measure the financial assets fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
The fair values of the Company’s pension plan assets at December 31 by asset category are as follows:
 
Fair Value Measurements Using
 
Fair Value Measurements Using
  
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
 
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
  
2013
 
  
 
2012
 
  
Assets
  
 
  
 
  
 
  
 
  
 
  
 
  
 
  
Cash and cash equivalents
$
88

 
$
247

 
$

 
$
335

 
$
142

 
$
587

 
$

 
$
729

Investment funds
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed markets equities
808

 
7,643

 

 
8,451

 
683

 
5,986

 

 
6,669

Emerging markets equities
163

 
1,036

 

 
1,199

 
121

 
771

 

 
892

Government and agency obligations
293

 
1,180

 

 
1,473

 
279

 
720

 

 
999

Corporate obligations
188

 
77

 

 
265

 
166

 
94

 

 
260

Fixed income obligations
17

 
145

 

 
162

 
14

 
206

 

 
220

Real estate (1)
4

 
57

 
49

 
110

 
4

 
14

 
141

 
159

Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed markets
2,546

 

 

 
2,546

 
2,277

 

 

 
2,277

Fixed income securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Government and agency obligations
2

 
1,096

 

 
1,098

 
2

 
1,052

 

 
1,054

Corporate obligations

 
741

 

 
741

 

 
1,008

 

 
1,008

Mortgage and asset-backed securities

 
299

 

 
299

 

 
269

 

 
269

Other investments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Insurance contracts (2)

 
128

 
540

 
668

 

 
117

 
496

 
613

Derivatives
1

 

 

 
1

 

 
162

 

 
162

Other

 
54

 
33

 
87

 

 
53

 
55

 
108

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives
$

 
$

 
$

 
$

 
$

 
$
70

 
$

 
$
70

 
$
4,110

 
$
12,703


$
622


$
17,435


$
3,688


$
10,969


$
692


$
15,349

(1) 
The plans’ Level 3 investments in real estate funds are generally valued by market appraisals of the underlying investments in the funds.
(2) 
The plans’ Level 3 investments in insurance contracts are generally valued using a crediting rate that approximates market returns and invest in underlying securities whose market values are unobservable and determined using pricing models, discounted cash flow methodologies, or similar techniques.
The table below provides a summary of the changes in fair value, including transfers in and/or out, of all financial assets measured at fair value using significant unobservable inputs (Level 3) for the Company’s pension plan assets:
 
2013
 
2012
  
Insurance
Contracts
 
Real
Estate
 
Other
 
Total
 
Insurance
Contracts
 
Real
Estate
 
Other
 
Total
Balance January 1
$
496

 
$
141

 
$
55

 
$
692

 
$
428

 
$
144

 
$
65

 
$
637

Actual return on plan assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Relating to assets still held at December 31
30

 

 
1

 
31

 
35

 
20

 
(2
)
 
53

Relating to assets sold during the year
1

 
(1
)
 
3

 
3

 
1

 
(12
)
 
5

 
(6
)
Purchases
18

 

 
3

 
21

 
21

 

 
4

 
25

Sales
(2
)
 

 
(29
)
 
(31
)
 
(11
)
 
(1
)
 
(14
)
 
(26
)
Transfers (out of) into Level 3
(3
)
 
(91
)
 

 
(94
)
 
22

 
(10
)
 
(3
)
 
9

Balance December 31
$
540

 
$
49

 
$
33

 
$
622

 
$
496

 
$
141

 
$
55

 
$
692


The fair values of the Company’s other postretirement benefit plan assets at December 31 by asset category are as follows:
 
Fair Value Measurements Using
 
Fair Value Measurements Using
  
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
 
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
  
2013
 
  
 
2012
 
  
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
47

 
$
20

 
$

 
$
67

 
$
27

 
$
48

 
$

 
$
75

Investment funds
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed markets equities
54

 
667

 

 
721

 
37

 
501

 

 
538

Emerging markets equities
36

 
95

 

 
131

 
37

 
75

 

 
112

Fixed income obligations
3

 
14

 

 
17

 
3

 
23

 

 
26

Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed markets
199

 

 

 
199

 
139

 

 

 
139

Fixed income securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Government and agency obligations

 
257

 

 
257

 

 
298

 

 
298

Corporate obligations

 
281

 

 
281

 

 
310

 

 
310

Mortgage and asset-backed securities

 
219

 

 
219

 

 
238

 

 
238

Other fixed income obligations

 
21

 

 
21

 

 
24

 

 
24

 
$
339

 
$
1,574

 
$

 
$
1,913

 
$
243

 
$
1,517

 
$

 
$
1,760


The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Company’s U.S. pension and other postretirement benefit plans is allocated 40% to 60% in U.S. equities, 20% to 40% in international equities, 15% to 25% in fixed-income investments, and up to 5% in cash and other investments. The portfolio’s equity weighting is consistent with the long-term nature of the plans’ benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 13%, reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For non-U.S. pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines.
Expected Contributions
Contributions to the pension plans and other postretirement benefit plans during 2014 are expected to be approximately $250 million and $75 million, respectively.

Expected Benefit Payments
Expected benefit payments are as follows:
 
Pension
Benefits
 
Other
Postretirement
Benefits
2014
$
651

 
$
119

2015
663

 
129

2016
675

 
134

2017
699

 
139

2018
739

 
145

2019 — 2023
4,440

 
811


Expected benefit payments are based on the same assumptions used to measure the benefit obligations and include estimated future employee service.

Amounts Recognized in Other Comprehensive Income
Net loss amounts reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Net loss amounts in excess of certain thresholds are amortized into net pension and other postretirement benefit cost over the average remaining service life of employees. The following amounts were reflected as components of OCI:
 
Pension Plans
 
Other Postretirement
Benefit Plans
Years Ended December 31
2013
 
2012
 
2011
 
2013
 
2012
 
2011
Net gain (loss) arising during the period
$
3,189

 
$
(1,907
)
 
$
(1,628
)
 
$
499

 
$
(24
)
 
$
106

Prior service credit (cost) arising during the period
203

 
(13
)
 
783

 
26

 
78

 
133

 
$
3,392

 
$
(1,920
)
 
$
(845
)
 
$
525

 
$
54

 
$
239

Net loss amortization included in benefit cost
$
407

 
$
256

 
$
196

 
$
23

 
$
31

 
$
38

Prior service (credit) cost amortization included in benefit cost
(71
)
 
(71
)
 
5

 
(73
)
 
(66
)
 
(55
)
 
$
336

 
$
185

 
$
201

 
$
(50
)
 
$
(35
)
 
$
(17
)

The estimated net loss (gain) and prior service cost (credit) amounts that will be amortized from AOCI into net pension and postretirement benefit cost during 2014 are $214 million and $(146) million, respectively, for pension plans and are $2 million and $(75) million, respectively, for other postretirement benefit plans.

Actuarial Assumptions
The Company reassesses its benefit plan assumptions on a regular basis. The weighted average assumptions used in determining pension plan and U.S. pension and other postretirement benefit plan information are as follows:
 
Pension Plans
 
U.S. Pension and Other
Postretirement Benefit Plans
December 31
2013

 
2012

 
2011

 
2013

 
2012

 
2011

Net periodic benefit cost
 
 
 
 
 
 
 
 
 
 
 
Discount rate
3.90
%
 
4.70
%
 
5.20
%
 
4.10
%
 
4.80
%
 
5.40
%
Expected rate of return on plan assets
7.50
%
 
7.50
%
 
7.50
%
 
8.50
%
 
8.70
%
 
8.70
%
Salary growth rate
4.20
%
 
4.00
%
 
4.20
%
 
4.50
%
 
4.50
%
 
4.50
%
Benefit obligation
 
 
 
 
 
 
 
 
 
 
 
Discount rate
4.50
%
 
3.90
%
 
4.70
%
 
5.10
%
 
4.10
%
 
4.80
%
Salary growth rate
4.00
%
 
4.20
%
 
4.00
%
 
4.50
%
 
4.50
%
 
4.50
%

For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid and is determined on a plan basis. In developing the expected rate of return within each plan, long-term historical returns data are considered as well as actual returns on the plan assets and other capital markets experience. Using this reference information, the long-term return expectations for each asset category and a weighted average expected return for each plan’s target portfolio is developed, according to the allocation among those investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2014, the Company’s expected rate of return will range from 7.30% to 8.75% compared to a range of 6.00% to 8.75% in 2013 for its U.S. pension and other postretirement benefit plans.
The health care cost trend rate assumptions for other postretirement benefit plans are as follows:
December 31
2013
 
2012
Health care cost trend rate assumed for next year
7.1
%
 
7.5
%
Rate to which the cost trend rate is assumed to decline
4.6
%
 
5.0
%
Year that the trend rate reaches the ultimate trend rate
2027

 
2018


A one percentage point change in the health care cost trend rate would have had the following effects:
 
One Percentage Point
  
Increase
 
Decrease
Effect on total service and interest cost components
$
38

 
$
(30
)
Effect on benefit obligation
316

 
(262
)


Savings Plans
The Company also maintains defined contribution savings plans in the United States. The Company matches a percentage of each employee’s contributions consistent with the provisions of the plan for which the employee is eligible. Total employer contributions to these plans in 2013, 2012 and 2011 were $138 million, $146 million and $166 million, respectively.

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