Retirement Benefits

PSE has a defined benefit pension plan covering substantially all PSE employees. Pension benefits earned are a function of age, salary and years of service. PSE also maintains a non-qualified Supplemental Executive Retirement Plan (SERP) for its key senior management employees. In addition to providing pension benefits, PSE provides certain health care and life insurance benefits for employees. These benefits are provided principally through an insurance company. The insurance premiums are based on the benefits provided during the year, and are paid primarily by retirees.

The following tables summarize the Company’s change in benefit obligation, change in plan assets and amounts recognized in the Statements of Financial Position for the years ended December 31, 2012 and 2011:



Puget Energy and Puget Sound Energy	Qualified Pension Benefits						SERP Pension Benefits							Other Benefits
(Dollars in Thousands)	2012			2011			2012			2011				2012			2011
Change in benefit obligation:
Benefit obligation at beginning of period	$	565,997		$	532,615		$	48,370		$	44,322			$	16,436		$	16,579
Service cost	16,926			15,822			1,073			1,241				139			113
Interest cost	25,986			26,263			2,152			2,192				751			806
Amendment	—			—			(122		)	—				—			—
Actuarial loss	40,914			18,485			5,483			4,467				1,199			384
Benefits paid	(33,533		)	(27,188		)	(5,161		)	(2,687		)		(1,523		)	(1,855		)
Medicare part D subsidy received	—			—			—			—				670			409
Curtailment loss/(gain)	—			—			—			(1,165		)	¹	—			—
Benefit obligation at end of period	$	616,290		$	565,997		$	51,795		$	48,370			$	17,672		$	16,436

_________________


¹	A curtailment gain was recognized in OCI due to the plan amendment that ceased SERP benefits for non-officers still in the plan as of December 31, 2011.



Puget Energy and Puget Sound Energy	Qualified Pension Benefits						SERP Pension Benefits						Other Benefits
(Dollars in Thousands)	2012			2011			2012			2011			2012			2011
Change in plan assets:
Fair value of plan assets at beginning of period	$	479,786		$	526,469		$	—		$	—		$	7,206		$	8,288
Actual return on plan assets	62,130			(24,495		)	—			—			1,100			(170		)
Employer contribution	22,800			5,000			5,161			2,687			758			943
Benefits paid	(33,533		)	(27,188		)	(5,161		)	(2,687		)	(1,523		)	(1,855		)
Fair value of plan assets at end of period	$	531,183		$	479,786		$	—		$	—		$	7,541		$	7,206
Funded status at end of period	$	(85,107	)	$	(86,211	)	$	(51,795	)	$	(48,370	)	$	(10,131	)	$	(9,230	)



Puget Energy and Puget Sound Energy	Qualified Pension Benefits						SERP Pension Benefits						Other Benefits
(Dollars in Thousands)	2012			2011			2012			2011			2012			2011
Amounts recognized in Statement of Financial Position consist of:
Current liabilities	$	—		$	—		$	(5,040	)	$	(6,137	)	$	(460	)	$	(468	)
Noncurrent liabilities	(85,107		)	(86,211		)	(46,755		)	(42,233		)	(9,671		)	(8,762		)
Total	$	(85,107	)	$	(86,211	)	$	(51,795	)	$	(48,370	)	$	(10,131	)	$	(9,230	)

The following tables summarize Puget Energy and Puget Sound Energy's pension benefit amounts recognized in Accumulated Other Comprehensive income for the years ended December 31, 2012 and 2011:



Puget Energy	Qualified Pension Benefits						SERP Pension Benefits					Other Benefits
(Dollars in Thousands)	2012			2011			2012			2011		2012		2011
Amounts recognized in Accumulated Other Comprehensive Income consist of:
Net loss/(gain)	$	49,001		$	34,781		$	12,818		$	8,038	$	763	$	282
Prior service cost	(17,741		)	(19,721		)	(122		)	—		—		—
Total	$	31,260		$	15,060		$	12,696		$	8,038	$	763	$	282



Puget Sound Energy	Qualified Pension Benefits						SERP Pension Benefits					Other Benefits
(Dollars in Thousands)	2012			2011			2012			2011		2012			2011
Amounts recognized in Accumulated Other Comprehensive Income consist of:
Net loss/(gain)	$	269,401		$	264,098		$	17,928		$	13,878	$	(2,175	)	$	(2,955	)
Prior service cost/(credit)	(14,098		)	(15,671		)	(110		)	305		36			72
Transition obligations	—			—			—			—		—			50
Total	$	255,303		$	248,427		$	17,818		$	14,183	$	(2,139	)	$	(2,833	)

The following tables summarize Puget Energy's and Puget Sound Energy's net periodic benefit cost for the years ended December 31, 2012, 2011 and 2010:



Puget Energy	Qualified Pension Benefits									SERP Pension Benefits						Other Benefits
(Dollars in Thousands)	2012			2011			2010			2012		2011		2010		2012			2011			2010
Components of net periodic benefit cost:
Service cost	$	16,926		$	15,822		$	16,089		$	1,073	$	1,241	$	1,024	$	139		$	113		$	106
Interest cost	25,986			26,263			27,975			2,152		2,192		2,165		751			806			880
Expected return on plan assets	(36,203		)	(35,344		)	(32,941		)	—		—				(435		)	(502		)	(510		)
Amortization of prior service cost/(credit)	(1,980		)	(1,980		)	(165		)	—		—		—		—			—			—
Amortization of net loss	768			—			70			702		360		—		53			(46		)	(67		)
Net periodic benefit cost	$	5,497		$	4,761		$	11,028		$	3,927	$	3,793	$	3,189	$	508		$	371		$	409



Puget Sound Energy	Qualified Pension Benefits									SERP Pension Benefits						Other Benefits
(Dollars in Thousands)	2012			2011			2010			2012		2011		2010		2012			2011			2010
Components of net periodic benefit cost:
Service cost	$	16,926		$	15,822		$	16,089		$	1,073	$	1,241	$	1,024	$	139		$	113		$	106
Interest cost	25,986			26,263			27,975			2,152		2,192		2,165		751			806			880
Expected return on plan assets	(41,533		)	(44,128		)	(43,892		)	—		—		—		(435		)	(502		)	(509		)
Amortization of prior service cost/(credit)	(1,573		)	(1,573		)	548			293		563		562		35			63			132
Amortization of net loss/(gain)	15,015			10,250			7,325			1,432		1,194		769		(245		)	(481		)	(553		)
Amortization of transition obligation	—			—			—			—		—		—		50			50			50
Net periodic benefit cost	$	14,821		$	6,634		$	8,045		$	4,950	$	5,190	$	4,520	$	295		$	49		$	106

The following tables summarize Puget Energy's and Puget Sound Energy's benefit obligations recognized in other comprehensive income for the years ended December 31, 2012 and 2011:



Puget Energy	Qualified Pension Benefits					SERP Pension Benefits						Other Benefits
(Dollars in Thousands)	2012			2011		2012			2011			2012			2011
Other changes (pre-tax) in plan assets and benefit obligations recognized in other comprehensive income:
Net loss/(gain)	$	14,988		$	78,324	$	5,483		$	3,302		$	534		$	1,056
Amortization of net loss/(gain)	(768		)	—		(703		)	(360		)	(53		)	46
Prior service credit	—			—		(122		)	—			—			—
Amortization of prior service credit	1,980			1,980		—			—			—			—
Total change in other comprehensive income for year	$	16,200		$	80,304	$	4,658		$	2,942		$	481		$	1,102



Puget Sound Energy	Qualified Pension Benefit						SERP Pension Benefits						Other Benefits
(Dollars in Thousands)	2012			2011			2012			2011			2012			2011
Other changes (pre-tax) in plan assets and benefit obligations recognized in other comprehensive income:
Net loss/(gain)	$	20,318		$	87,108		$	5,483		$	3,302		$	534		$	1,056
Amortization of net (loss)/gain	(15,015		)	(10,250		)	(1,433		)	(1,194		)	245			481
Prior service cost/(credit)	—			—			(122		)	—			—			—
Amortization of prior service cost/(credit)	1,573			1,573			(293		)	(562		)	(35		)	(62		)
Amortization of transition obligation	—			—			—			—			(50		)	(50		)
Total change in other comprehensive income for year	$	6,876		$	78,431		$	3,635		$	1,546		$	694		$	1,425

The estimated net/(loss) gain and prior service/(cost) credit for the pension plans that will be amortized from accumulated OCI into net periodic benefit cost in 2013 by Puget Energy are $(2.6) million and $2.0 million, respectively. The estimated net (loss)/gain for the SERP that will be amortized from accumulated OCI into net periodic benefit cost in 2013 are $(1.5) million. The estimated prior service (cost)/credit for the SERP that will be amortized from accumulated OCI into net periodic benefit cost in 2013 is immaterial. The estimated net (loss)/gain, prior service cost/(credit) and transition/(obligation) asset for the other postretirement plans that will be amortized from accumulated OCI into net periodic benefit cost in 2013 are immaterial.

The estimated net (loss)/gain and prior service (cost)/credit for the pension plans that will be amortized from accumulated OCI into net periodic benefit cost in 2013 by Puget Sound Energy are $(20.3) million and $1.6 million, respectively. The estimated net loss/(gain) and prior service (cost)/credit for the SERP that will be amortized from accumulated OCI into net periodic benefit cost in 2013 are $(2.2) million. The estimated prior service (cost)/credit for the SERP that will be amortized from accumulated OCI into net periodic benefit cost in 2013 is immaterial. The estimated net (loss)/gain for the other postretirement plan that will be amortized from accumulated OCI into net periodic benefit cost in 2013 is $0.1 million and prior service (cost)/credit and transition (obligation)/asset for the other postretirement plans are immaterial.

The aggregate expected contributions by the Company to fund the retirement plan, SERP and the other postretirement plans for the year ending December 31, 2013 are expected to be at least $20.4 million, $5.0 million and $0.8 million, respectively.

Assumptions

In accounting for pension and other benefit obligations and costs under the plans, the following weighted-average actuarial assumptions were used by the Company:



	Qualified Pension Benefits						SERP Pension Benefits						Other Benefits
Benefit Obligation Assumptions	2012		2011		2010		2012		2011		2010		2012		2011		2010
Discount rate ¹	4.15	%	4.75	%	5.15	%	4.15	%	4.75	%	5.15	%	4.15	%	4.75	%	5.15	%
Rate of compensation increase	4.50	%	4.50	%	4.50	%	4.50	%	4.50	%	4.50	%	4.50	%	4.50	%	4.50	%
Medical trend rate	—		—		—		—		—		—		7.50	%	7.50	%	8.00	%
Benefit Cost Assumptions
Discount rate	4.75	%	5.15	%	5.75	%	4.75	%	5.15	%	5.75	%	4.75	%	5.15	%	5.75	%
Rate of plan assets	7.75	%	7.75	%	8.00	%	—		—		—		7.50	%	7.80	%	7.80	%
Rate of compensation increase	4.50	%	4.50	%	4.50	%	4.50	%	4.50	%	4.50	%	4.50	%	4.50	%	4.50	%
Medical trend rate	—		—		—		—		—		—		7.50	%	8.00	%	8.50	%

_______________


¹	The Company calculates the present value of the pension liability using a discount rate of 4.15% which represents the single-rate equivalent of the AA rated corporate bond yield curve.

The assumed medical inflation rate used to determine benefit obligations is 7.50% in 2013 grading down to 4.80% in 2014. A 1.0% change in the assumed medical inflation rate would have the following effects:



	2012				2011
(Dollars in Thousands)	1% Increase		1% Decrease		1% Increase		1% Decrease
Effect on post-retirement benefit obligation	$	92	$	92	$	97	$	85
Effect on service and interest cost components	4		4		5		4

The Company has selected the expected return on plan assets based on a historical analysis of rates of return and the Company’s investment mix, market conditions, inflation and other factors. The expected rate of return is reviewed annually based on these factors. The Company’s accounting policy for calculating the market-related value of assets for the Company’s retirement plan is as follows. PSE market-related value of assets is based on a five-year smoothing of asset gains/losses measured from the expected return on market-related assets. This is a calculated value that recognizes changes in fair value in a systematic and rational manner over five years. The same manner of calculating market-related value is used for all classes of assets, and is applied consistently from year to year.

Puget Energy’s pension and other postretirement benefits income or costs depend on several factors and assumptions, including plan design, timing and amount of cash contributions to the plan, earnings on plan assets, discount rate, expected long-term rate of return, mortality and health care costs trends. Changes in any of these factors or assumptions will affect the amount of income or expense that Puget Energy records in its financial statements in future years and its projected benefit obligation. Puget Energy has selected an expected return on plan assets based on a historical analysis of rates of return and Puget Energy’s investment mix, market conditions, inflation and other factors. As required by merger accounting rules, market-related value was reset to market value effective with the merger.

The discount rates were determined by using market interest rate data and the weighted-average discount rate from Citigroup Pension Liability Index Curve. The Company also takes into account in determining the discount rate the expected changes in market interest rates and anticipated changes in the duration of the plan liabilities.

Plan Benefits

The expected total benefits to be paid under the next five years and the aggregate total to be paid for the five years thereafter are as follows:



(Dollars in Thousands)	2013		2014		2015		2016		2017		2018-2022
Qualified Pension total benefits	$	38,500	$	38,400	$	38,800	$	39,000	$	40,000	$	216,900
SERP Pension total benefits	5,040		3,799		3,437		3,510		1,883		21,338
Other Benefits total with Medicare Part D subsidy	1,326		1,282		1,315		1,259		1,199		6,853
Other Benefits total without Medicare Part D subsidy	1,713		1,691		1,656		1,607		1,557		7,031

Plan Assets

Plan contributions and the actuarial present value of accumulated plan benefits are prepared based on certain assumptions pertaining to interest rates, inflation rates and employee demographics, all of which are subject to change. Due to uncertainties inherent in the estimations and assumptions process, changes in these estimates and assumptions in the near term may be material to the financial statements.

The Company has a Retirement Plan Committee that establishes investment policies, objectives and strategies designed to balance expected return with a prudent level of risk. All changes to the investment policies are reviewed and approved by the Retirement Plan Committee prior to being implemented.

The Retirement Plan Committee invests trust assets with investment managers who have historically achieved above-median long-term investment performance within the risk and asset allocation limits that have been established. Interim evaluations are routinely performed with the assistance of an outside investment consultant. To obtain the desired return needed to fund the pension benefit plans, the Retirement Plan Committee has established investment allocation percentages by asset classes as follows:



	Allocation
Asset Class	Minimum	Target	Maximum
Domestic large cap equity	25%	32%	40%
Domestic small cap equity	0%	10%	15%
Non-U.S. equity	10%	20%	30%
Tactical asset allocation	0%	5%	10%
Fixed income	15%	23%	30%
Real estate	0%	0%	10%
Absolute return	5%	10%	15%
Cash	0%	0%	5%

Plan Fair Value Measurements

ASC 715, “Compensation – Retirement Benefits” (ASC 715) directs companies to provide additional disclosures about plan assets of a defined benefit pension or other postretirement plan. The objectives of the disclosures are to disclose the following: (1) how investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies; (2) major categories of plan assets; (3) inputs and valuation techniques used to measure the fair value of plan assets; (4) effect of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets for the period; and (5) significant concentrations of risk within plan assets.

ASC 820 allows the reporting entity, as a practical expedient, to measure the fair value of investments that do not have readily determinable fair values on the basis of the net asset value per share of the investment if the net asset value of the investment is calculated in a matter consistent with ASC 946, “Financial Services – Investment Companies.” The standard requires disclosures about the nature and risk of the investments and whether the investments are probable of being sold at amounts different from the net asset value per share.

The following table sets forth by level, within the fair value hierarchy, the qualified pension plan as of December 31, 2012 and 2011:



	Recurring Fair Value Measures									Recurring Fair Value Measures
	As of December 31, 2012									As of December 31, 2011
(Dollars in Thousands)	Level 1		Level 2		Level 3		Total			Level 1		Level 2		Level 3		Total
Assets:
Equities:
Non-US equity ¹	$	56,717	$	49,304	$	—	$	106,021		$	48,382	$	42,132	$	—	$	90,514
Domestic large cap equity ²	136,994		28,890		—		165,884			124,303		29,547		—		153,850
Domestic small cap equity ³	51,264		—		—		51,264			45,650		—		—		45,650
Total equities	244,975		78,194		—		323,169			218,335		71,679		—		290,014
Tactical asset allocation ⁴	—		26,425		—		26,425			—		26,922		—		26,922
Fixed income securities ⁵	119,939		—		—		119,939			106,573		580		—		107,153
Absolute return ⁶	—		—		55,615		55,615			—		—		45,319		45,319
Cash and cash equivalents ⁷	—		6,019		—		6,019			—		9,015		—		9,015
Subtotal	$	364,914	$	110,638	$	55,615	$	531,167		$	324,908	$	108,196	$	45,319	$	478,423
Net (payable) receivable							(173		)							1,088
Accrued income							189									275
Total assets							$	531,183								$	479,786

_________________


¹	Non – US Equity investments are comprised of a (1) mutual fund; and a (2) commingled fund. The investment in the mutual fund is valued using quoted market prices multiplied by the number of shares owned as of December 31, 2012. The investment in the commingled fund is valued at the net asset value per share multiplied by the number of shares held as of December 31, 2012.


²	Domestic large cap equity investments are comprised of (1) common stock, and a (2) commingled fund. Investments in common stock are valued using quoted market prices multiplied by the number of shares owned as of December 31, 2012. The investment in the commingled fund is valued at the net asset value per share multiplied by the number of shares held as of December 31, 2012.


³	Domestic small cap equity investments are comprised of (1) common stock and a (2) mutual fund. The investments in common stock are valued using quoted market prices multiplied by the number of shares owned as of December 31, 2012. The investment in the mutual fund is valued using quoted market prices multiplied by the number of shares owned as of December 31, 2012.


⁴	The tactical asset allocation investment is comprised of a commingled fund, which is valued at the net asset value per share multiplied by the number of shares held as of the measurement date.


⁵	Fixed income securities consist of a mutual fund. The investment in the mutual fund is valued using quoted market prices multiplied by the number of shares owned as of December 31, 2012.


⁶	As of December 31, 2012 absolute return investments consist of two partnerships. The partnerships are valued using the financial reports as of December 31, 2012. These investments are a Level 3 under ASC 820 because the significant valuation inputs are primarily internal to the partnershipswith little third party involvement.


⁷	The investment consists of a money market fund, which is valued at the net asset value per share of $1.00 per unit as of December 31, 2012. The money market fund invests primarily in commercial paper, notes, repurchase agreements, and other evidences of indebtedness which are payable on demand or short-term in nature.

Level 3 Roll-Forward

The following table sets forth a reconciliation of changes in the fair value of the plan’s Level 3 assets:



	As of December 31, 2012						As of December 31, 2011
(Dollars in Thousands)	Partnership		Mutual Funds		Total		Partnership			Mutual Funds			Total
Balance at beginning of year	$	45,319	$	—	$	45,319	$	35,481		$	12,619		$	48,100
Additional investments	7,021		—		7,021		11,635			—			11,635
Distributions	—		—		—		—			(11,635		)	(11,635		)
Realized losses on distributions	—		—		—		—			(290		)	(290		)
Unrealized gains relating to instruments still held at the reporting date	3,274		—		3,274		(1,797		)	599			(1,198		)
Transferred out of level 3 ¹	—		—		—		—			(1,293		)	(1,293		)
Balance at end of year	$	55,614	$	—	$	55,614	$	45,319		$	—		$	45,319

_________________


¹	The plan had no transfers between level 2 and level 1 during the years ended December 31, 2012 or 2011.

The following table sets forth by level, within the fair value hierarchy, the Other Benefits plan assets which consist of insurance benefits for retired employees, at fair value:



	Recurring Fair Value Measures						Recurring Fair Value Measures
	As of December 31, 2012						As of December 31, 2011
(Dollars in Thousands)	Level 1		Level 2		Total		Level 1		Level 2		Total
Assets:
Mutual fund ¹	$	7,472	$	—	$	7,472	$	7,137	$	—	$	7,137
Cash equivalents ²	—		69		69		—		69		69
Total assets	$	7,472	$	69	$	7,541	$	7,137	$	69	$	7,206

_______________


¹	This is a publicly traded balanced mutual fund. The fund seeks regular income, conservation of principal, and an opportunity for long-term growth of principal and income. The fair value is determined by taking the number of shares owned by the plan, and multiplying by the market price as of December 31, 2012.


²	This is a money market fund. The money market fund investments are valued at the net asset value per share of $1.00 per unit as of December 31, 2012. The money market fund invests primarily in commercial paper, notes, repurchase agreements, and other evidences of indebtedness which are payable on demand or short-term in nature.