RETIREMENT PENSION PLANS

The company sponsors defined benefit pension plans that cover certain of its U.S. and non-U.S. employees. Pension benefits for salaried employees are based on years of credited service and compensation. Pension benefits for hourly employees are based on years of service and specified benefit amounts. The company’s funding policy provides that annual contributions to the pension trusts will be at least equal to the minimum amounts required by ERISA in the U.S. and the actuarial recommendations or statutory requirements in other countries.

The mortality assumptions for participants in the company’s U.S. plans incorporates future mortality improvements from tables published by the SOA. In October 2014, the SOA issued new mortality and mortality improvement tables that raised the life expectancies. The company reviewed the new SOA mortality and mortality improvement tables and utilized an actuary to conduct a study based on the company’s plan participants. The company determined that the best representation of the plans' mortality is to utilize the new SOA mortality and mortality improvement tables as the reference table for credibility-weighted mortality rates, blended with company specific mortality based on the study conducted by the actuary. The company incorporated the updated tables into the 2015 year-end measurement of the plans’ benefit obligations. As a result of this change in actuarial assumption, the company’s U.S. pension obligations increased by $24 million in the fourth quarter of fiscal year 2015. The company considers improvement scales released annually by the SOA. These did not have an impact in fiscal years 2017 and 2016.

On August 1, 2010, Meritor amended its defined benefit pension plan in the United Kingdom to cease the accrual of future benefits for all of its active plan participants. Subsequent to the freeze date, the company began making contributions to its defined contribution savings plan on behalf of the affected employees. The amount of the savings plan contribution is based on a percentage of the employees’ pay. These changes did not affect then-current retirees. The company began recording the impact of the plan freeze in the fourth quarter of fiscal year 2010. Subsequent to the plan freeze, accumulated actuarial losses are being amortized into net periodic pension expense over the average life expectancy of inactive plan participants of approximately 26 years rather than over their remaining average service life.

In April 2007, the company announced a freeze of its defined benefit pension plan for salaried and non-represented employees in the United States, effective January 1, 2008. The change affected approximately 3,800 employees including certain employees who continued to accrue benefits for an additional transition period, ending June 30, 2011. After these freeze dates, the company started making additional contributions to its defined contribution savings plan on behalf of the affected employees. The amount of the savings plan contribution is based on a percentage of the employees’ pay, with the contribution percentage increasing as a function of employees’ age. These changes do not affect plan participants who had retired prior to the freeze dates or represented employees. Accumulated actuarial losses are being amortized into net periodic pension expense over the average life expectancy of inactive plan participants of approximately 18 years.

In June 2013, the company amended its U.S. Retirement Plan to allow all terminated vested participants with an accrued benefit of $5,000 or less to receive a full lump-sum distribution of their benefit. The lump-sum amounts were rolled into individual retirement accounts for those participants that had an accrued benefit of $1,000 to $5,000 who did not make an affirmative election to receive their benefits. For those participants with an accrued benefit of less than $1,000, the benefits were automatically distributed to the participant.

Effective October 2014, the company amended the U.S. Retirement Plan to include an additional distribution option in the form of a Lump Sum Benefit from the Plan. The majority of Plan members are eligible for this distribution option following termination or when making their retirement payment election. The Lump Sum Benefit equals the present value of a member's vested accrued benefit paid in one lump sum payment.

During fiscal year 2015, the company settled the remaining liabilities associated with its Canadian pension plans through lump-sum payments made from plan assets to plan participants and by purchasing annuity contracts from an insurance company. The company recognized a primarily non-cash pre-tax settlement loss of $16 million associated with the annuity purchases and lump-sum payments. The company settled a net pension obligation of $16 million using $20 million of pension plan assets, such that the assets and liabilities were derecognized from the balance sheet during the quarter ended September 30, 2015.

Additionally, in fiscal year 2015, the company settled the remaining liabilities associated with its German pension plans by purchasing annuity contracts from an insurance company. The company recognized a primarily non-cash pre-tax settlement loss of $43 million associated with the annuity purchases. The company settled a net pension obligation of $91 million, which was derecognized from the balance sheet during the quarter ended September 30, 2015.

The company’s pension obligations are generally measured as of September 30, 2017, 2016 and 2015, while the pension obligations associated with the fourth quarter fiscal year 2015 settled Canadian and German pension plans were measured as of August 31, 2015. The U.S. plans include qualified and non-qualified pension plans. The company’s only significant remaining non-U.S. plan is located in the United Kingdom.

The following are the significant assumptions used in the measurement of the projected benefit obligation (PBO) and net periodic pension expense:



	U.S. Plans
	2017			2016			2015
Discount rate	3.70%	—	3.75%	3.50%	—	3.55%	4.25%	—	4.35%
Assumed return on plan assets (beginning of the year)	7.75%			7.75%			8.00%



	Non-U.S. Plans ⁽²⁾
	2017	2016	2015
Discount rate ⁽¹⁾	2.80%	2.50%	1.00%	—	3.80%
Assumed return on plan assets (beginning of the year) ⁽¹⁾	6.00%	6.00%	2.25%	—	7.25%
Rate of compensation increase ⁽³⁾	N/A	N/A	2.00%


⁽¹⁾	The discount rate for the company’s U.K. pension plan was 2.80 percent, 2.50 percent and 3.80 percent for 2017, 2016 and 2015, respectively. The assumed return on plan assets for this plan was 6.00 percent, 6.00 percent and 7.25 percent for 2017, 2016 and 2015, respectively.


⁽²⁾	In fiscal year 2015, our German and Canadian pension plans were settled. In 2017 and 2016, assumptions presented are for the U.K pension plan, which is the only significant non-U.S. plan remaining.


⁽³⁾	Rate of compensation increase for 2017 and 2016 is not applicable as the U.K. pension plan is frozen.

The discount rate is used to calculate the present value of the PBO at the balance sheet date and net periodic pension expense for the subsequent fiscal year. The rate used reflects a rate of return on high-quality fixed income investments that match the duration of expected benefit payments. Generally, the company uses a portfolio of long-term corporate AA/Aa bonds that match the duration of the expected benefit payments, except for the company's U.K. pension plan which uses an annualized yield curve, to establish the discount rate for this assumption.

The assumed return on plan assets is used to determine net periodic pension expense. The rate of return assumptions are based on projected long-term market returns for the various asset classes in which the plans are invested, weighted by the target asset allocations. An incremental amount for active plan asset management and diversification, where appropriate, is included in the rate of return assumption. The return assumption is reviewed annually.

The rate of compensation increase represents the long-term assumption for expected increases to salaries for pay-related plans. The accompanying disclosures include pension obligations associated with businesses classified as discontinued operations.

The following table reconciles the change in the PBO, the change in plan assets and amounts included in the consolidated balance sheet for the years ended September 30, 2017 and 2016, respectively (in millions):



	2017									2016
	U.S.			Non- U.S.			Total			U.S.			Non- U.S.			Total
PBO — beginning of year	$	1,112		$	616		$	1,728		$	1,042		$	614		$	1,656
Service cost	—			—			—			—			1			1
Interest cost	38			15			53			45			20			65
Actuarial gain	(32		)	(21		)	(53		)	105			115			220
Prior service cost	1			—			1			—			—			—
Benefit payments	(83		)	(30		)	(113		)	(80		)	(35		)	(115		)
Foreign currency rate changes	—			19			19			—			(99		)	(99		)
PBO — end of year	$	1,036		$	599		$	1,635		$	1,112		$	616		$	1,728
Change in plan assets
Fair value of assets — beginning of year	$	834		$	734		$	1,568		$	830		$	717		$	1,547
Actual return on plan assets	65			1			66			79			169			248
Employer contributions	5			1			6			5			1			6
Benefit payments	(83		)	(30		)	(113		)	(80		)	(35		)	(115		)
Foreign currency rate changes	—			24			24			—			(118		)	(118		)
Fair value of assets — end of year	$	821		$	730		$	1,551		$	834		$	734		$	1,568
Funded status	$	(215	)	$	131		$	(84	)	$	(278	)	$	118		$	(160	)

Amounts included in the consolidated balance sheet at September 30 are comprised of the following (in millions):



	2017									2016
	U.S.			Non-U.S.			Total			U.S.			Non-U.S.			Total
Non-current assets	$	—		$	135		$	135		$	—		$	123		$	123
Current liabilities	(5		)	—			(5		)	(6		)	—			(6		)
Retirement benefits-non-current	(210		)	(4		)	(214		)	(272		)	(5		)	(277		)
Net amount recognized	$	(215	)	$	131		$	(84	)	$	(278	)	$	118		$	(160	)

The following tables summarize the amounts included in Accumulated Other Comprehensive Loss net of tax related to pension liabilities as of September 30, 2017 and 2016 and changes recognized in Other Comprehensive Income (Loss) net of tax for the year ended September 30, 2017.



	Net Actuarial Loss
	U.S.			Non-U.S.			Total
Balance at September 30, 2016	$	454		$	190		$	644
Net prior service cost for the year	1			—			1
Net actuarial gain for the year	(36		)	11			(25		)
Amortization for the year	(22		)	(8		)	(30		)
Deferred tax impact	21			—			21
Balance at September 30, 2017	$	418		$	193		$	611

Balance at September 30, 2015	$	410		$	206		$	616
Net actuarial loss for the year	87			(11		)	76
Amortization for the year	(18		)	(5		)	(23		)
Deferred tax impact	(25		)	—			(25		)
Balance at September 30, 2016	$	454		$	190		$	644

The company estimates that $28 million of net actuarial losses will be amortized from accumulated other comprehensive loss into net periodic pension expense during fiscal year 2018. The non-current portion of the pension liability is included in Retirement Benefits in the consolidated balance sheet as follows (in millions):



	September 30,
	2017		2016
Pension liability	$	214	$	277
Retiree medical liability — long term (see Note 21)	86		414
Other	14		12
Total retirement benefits	$	314	$	703

In accordance with FASB guidance, the PBO, accumulated benefit obligation (ABO) and fair value of plan assets are required to be disclosed for all plans where the ABO is in excess of plan assets. The difference between the PBO and ABO is that the PBO includes projected compensation increases.

Additional information is as follows (in millions):



	2017						2016
	ABO Exceeds Assets		Assets Exceed ABO		Total		ABO Exceeds Assets		Assets Exceed ABO		Total
PBO	$	1,041	$	594	$	1,635	$	1,116	$	612	$	1,728
ABO	1,041		594		1,635		1,116		612		1,728
Plan Assets	821		730		1,551		834		734		1,568

The components of net periodic pension expense are as follows (in millions):



	2017			2016			2015
Service cost	$	—		$	1		$	2
Interest cost	53			65			70
Assumed rate of return on plan assets	(96		)	(99		)	(111		)
Amortization of —
Actuarial losses	30			23			26
Settlement loss	—			—			59
Net periodic pension expense (income)	$	(13	)	$	(10	)	$	46

Disclosures on investment policies and strategies, categories of plan assets, fair value measurements of plan assets, and significant concentrations of risk are included below.

Investment Policy and Strategy

The company’s primary investment objective for its pension plan assets is to generate a total investment return sufficient to meet present and future benefit payments while minimizing the company’s cash contributions over the life of the plans. In order to accomplish this objective, the company maintains target allocations to identify and manage exposures. The target asset allocation ranges for the U.S. plan are 20–50 percent equity investments, 30–60 percent fixed income investments and 10–25 percent alternative investments. Alternative investments include private equities, real estate, hedge funds, diversified growth funds, and partnership interests. The target asset allocation ranges for the non-U.S. plans are 15–35 percent equity investments, 30–60 percent fixed income investments, 0–10 percent real estate and 10–30 percent alternative investments.

Investment strategies and policies for the company’s pension plan assets reflect a balance of risk-reducing and return-seeking considerations. The objective of minimizing the volatility of assets relative to liabilities is addressed primarily through asset diversification. Assets are broadly diversified across several asset classes to achieve risk-adjusted returns that accomplish this objective.

The majority of pension plan assets are externally managed through active managers. Managers are only permitted to invest within established asset classes and follow the strategies for which they have been appointed. The company uses investment guidelines and reviews asset returns and investment decisions made by the managers to ensure that they are in accordance with the company’s strategies.

Concentration of Risk

The company seeks to mitigate risks relative to performance of the plan assets. Assets are invested in various classes with different risk and return characteristics in order to ensure that they are sufficient to pay benefits. The company’s investment strategies incorporate a return-seeking approach through equity and alternative investments, while seeking to minimize the volatility of the plans’ assets relative to its liabilities through investments in fixed income securities. The significant areas of risk related to these strategies include equity, interest rate, and operating risk.

A portion of plan assets is allocated to equity and alternative investments that are expected, over time, to earn higher returns. Within this return-seeking portfolio, asset diversification is utilized to reduce uncompensated risk.

Plan assets are also allocated to fixed income investments, which seek to minimize interest rate risk volatility relative to pension liabilities. The fixed income portfolio partially matches the long-dated nature of the pension liabilities reducing interest rate risk. Interest rate decreases generally increase the value of fixed income assets, partially offsetting the related increase in the liabilities, while interest rate increases generally result in a decline in the value of fixed income assets while reducing the present value of the liabilities.

Operating risks consist of the risks of inadequate diversification and weak controls. The company has established policies and procedures in order to mitigate this risk by monitoring investment manager performance, reviewing periodic compliance information, and ensuring that the plans’ managers invest in accordance with the company’s investment strategies.

Fair Value of Investments

The current FASB guidance provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:


•	Level 1 inputs use quoted prices in active markets for identical assets that the Plan has the ability to access.


•	Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets in active markets and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.


•	Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset.

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest priority level input that is significant to the valuation. The company's assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.

Following are descriptions, valuation methodologies and other information related to plan assets.

Cash and cash equivalents: The fair value of cash and cash equivalents is valued at cost.

Equity Securities: The overall equity category includes common and preferred stocks issued by U.S. and international companies as well as equity funds that invest in these instruments. All investments generally allow near-term (within 90 days of the measurement date) liquidity and are held in issues that are actively traded to facilitate transactions at minimum cost. The aggregate equity portfolio is diversified to avoid exposure to any investment strategy, single economic sector, industry group, or individual security.

The fair value of equity securities is determined by either direct or indirect quoted market prices. When the value of assets held in separate accounts is not published, the value is based on the underlying holdings, which are primarily direct quoted market prices on regulated financial exchanges.

Most of the equity investments allow daily redemptions, with some providing monthly liquidity or requiring a 30-day notice.

Fixed Income Securities: The overall fixed income category includes U.S. dollar-denominated and international marketable bonds and convertible debt securities as well as fixed income funds that invest in these instruments. All assets generally allow near-term liquidity and are held in issues which are actively traded to facilitate transactions at minimum cost. The aggregate fixed income portfolio is diversified to avoid exposure to any investment strategy, maturity, issuer or credit quality.

The fair value of fixed income securities is determined by either direct or indirect quoted market prices. When the value of assets held in separate accounts is not published, the value is based on the underlying holdings, which are primarily direct quoted market prices on regulated financial exchanges.

U.S. fixed income securities typically offer daily liquidity, with only one investment allowing quarterly redemptions. International and emerging fixed income investment vehicles generally provide daily liquidity.

Commingled Funds: The fair value of commingled funds is accounted for by a custodian. The custodian obtains valuations from underlying fund managers based on market quotes for the most liquid assets and alternative methods for assets that do not have sufficient trading activity to derive prices. The company and custodian review the methods used by the underlying managers to value the assets.

Real Estate: Real estate provides an indirect investment into a diversified and multi-sector portfolio of property assets. The fair value of real estate investments is valued by the fund managers. The fund managers value the real estate investments via independent third-party appraisals on a periodic basis. Assumptions used to revalue the properties are updated every quarter. For the component of the real estate portfolio under development, the investments are carried at cost, which approximates fair value, until they are completed and valued by a third-party appraiser.

Due to the long-term nature of real estate investments, liquidity is provided on a quarterly basis.

Futures Contracts: The plan enters into futures contracts in the normal course of its investing activities to manage market risk and to achieve overall investment portfolio objectives. The credit risk associated with these contracts is minimal as they are traded on organized exchanges and settled daily. The fair value of futures contracts is determined by direct quoted market prices. Cash margin for these futures contracts is included in Cash and Cash Equivalents in the leveling table.

Alternatives/Partnerships/Private Equity: This category includes investments in private equity and hedge funds. Such investments may be made directly or through pooled funds, including fund of funds structures. The fair market value of the company’s interest in partnerships and private equity is valued by the fund managers. The valuation is based on the net present value of observable inputs (dividends, cash flows, earnings, etc.), which are discounted at applicable discount rates. The company and custodian review the methods used by the underlying managers to value the assets.

Most of these investments offer quarterly redemption opportunities. Some partnerships and private equity investments, due to the nature of their investment strategy and underlying holdings, offer less frequent liquidity. When available, liquidity events are closely evaluated.

The valuation methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.

The fair value of plan assets at September 30, 2017 by asset category is as follows (in millions):



U.S. Plans	2017
Asset Category	Level 1		Level 2		Level 3		Total
Equity investments
U.S. – Large cap	$	54	$	—	$	—	$	54
U.S. – Small cap	26		—		—		26
Private equity	—		—		19		19
International equity	37		—		—		37
Equity investments measured at net asset value ⁽¹⁾	—		—		—		195
Total equity investments	$	117	$	—	$	19	$	331
Fixed income investments
U.S. fixed income	$	5	$	213	$	—	$	218
Emerging fixed income	—		22		—		22
Partnerships fixed income	14		—		—		14
Fixed income investments measured at net asset value ⁽¹⁾	—		—		—		37
Total fixed income	$	19	$	235	$	—	$	291
Alternatives – Partnerships	—		—		77		77
Alternatives – Partnerships measured at net asset value ⁽¹⁾	—		—		—		88
Cash and cash equivalents	—		34		—		34
Total assets at fair value	$	136	$	269	$	96	$	821

Non-U.S. Plans	2017
Asset Category	Level 1		Level 2		Level 3		Total
Equity investments
International equity	$	168	$	—	$	—	$	168
Total equity investments	$	168	$	—	$	—	$	168
Fixed income investments
Other fixed income investments	$	5	$	149	$	—	$	154
Fixed income investments measured at net asset value ⁽¹⁾	—		—		—		226
Total fixed income	$	5	$	149	$	—	$	380
Commingled funds	—		5		—		5
Alternative investments measured at net asset value ⁽¹⁾	—		—		—		136
Real estate measured at net asset value ⁽¹⁾	—		—		—		40
Cash and cash equivalents	—		1		—		1
Total assets at fair value	$	173	$	155	$	—	$	730


⁽¹⁾	In accordance with Subtopic 820-10, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the statement of financial position.

The fair value of plan assets at September 30, 2016 by asset category is as follows (in millions):



U.S. Plans	2016
Asset Category	Level 1		Level 2		Level 3		Total
Equity investments
U.S. – Large cap	$	71	$	—	$	—	$	71
U.S. – Small cap	22		—		—		22
Private equity	—		—		11		11
International equity	41		—		—		41
Equity investments measured at net asset value ⁽¹⁾	—		—		—		152
Total equity investments	$	134	$	—	$	11	$	297
Fixed income investments
U.S. fixed income	$	10	$	265	$	—	$	275
Emerging fixed income	—		20		—		20
Partnerships fixed income	—		—		1		1
Fixed income investments measured at net asset value ⁽¹⁾	—		—		—		45
Total fixed income	$	10	$	285	$	1	$	341
Alternatives – Partnerships	—		—		77		77
Alternatives – Partnerships measured at net asset value ⁽¹⁾	—		—		—		84
Cash and cash equivalents	—		35		—		35
Total assets at fair value	$	144	$	320	$	89	$	834

Non-U.S. Plans	2016
Asset Category	Level 1		Level 2		Level 3		Total
Equity investments
International equity	$	61	$	—	$	—	$	61
Equity investments measured at net asset value ⁽¹⁾	—		—		—		82
Total equity investments	$	61	$	—	$	—	$	143
Fixed income investments
Other fixed income investments	$	—	$	222	$	—	$	222
Fixed income investments measured at net asset value ⁽¹⁾	—		—		—		198
Total fixed income	$	—	$	222	$	—	$	420
Commingled funds	—		6		—		6
Alternative investments measured at net asset value ⁽¹⁾	—		—		—		114
Real estate measured at net asset value⁽¹⁾	—		—		—		37
Cash and cash equivalents	—		14		—		14
Total assets at fair value	$	61	$	242	$	—	$	734


⁽¹⁾	In accordance with Subtopic 820-10, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the statement of financial position.

Unfunded Commitment

As of September 30, 2017, the U.S. plan had $13 million of unfunded investment commitments related to plan assets. The majority of this amount is attributed to partnership investments that the plan will invest in gradually over the course of several years. Non-U.S. plans currently do not have any unfunded commitments.

The following table summarizes the changes in Level 3 pension plan assets measured at fair value on a recurring basis for the year ended September 30, 2017 (in millions):



U.S. Plans	2017
	Fair Value at October 1, 2016		Return on Plan Assets: Attributable to Assets Held at September 30, 2017		Purchases		Settlements			Net Transfers Into (Out of) Level 3		Fair Value at September 30, 2017
Asset Category
Private equity	$	11	$	4	$	4	$	—				$	19
Partnerships –
Fixed income	1		—		—		(1		)			—
Alternatives –
Partnerships	77		4		1		(5		)			77
Total Level 3 fair value	$	89	$	8	$	5	$	(6	)	$	—	$	96

The following table summarizes the changes in Level 3 pension plan assets measured at fair value on a recurring basis for the year ended September 30, 2016 (in millions):



U.S. Plans	2016
	Fair Value at October 1, 2015		Return on Plan Assets: Attributable to Assets Held at September 30, 2016			Purchases		Settlements			Net Transfers Into (Out of) Level 3		Fair Value at September 30, 2016
Asset Category
Private equity	$	15	$	(4	)	$	—	$	—		$	—	$	11
Partnerships –
Fixed income	1		—			—		—			—		1
Alternatives –
Partnerships	84		(5		)	—		(2		)	—		77
Total Level 3 fair value	$	100	$	(9	)	$	—	$	(2	)	$	—	$	89

Information about the expected cash flows for the U.S. and non-U.S. pension plans is as follows (in millions):



	U.S.		Non U.S.		Total
Expected employer contributions:
Fiscal 2018	$	5	$	1	$	6
Expected benefit payments:
Fiscal 2018	72		18		90
Fiscal 2019	73		18		91
Fiscal 2020	72		19		91
Fiscal 2021	71		19		90
Fiscal 2022	70		20		90
Fiscal 2023-2027	331		110		441

The company also sponsors certain defined contribution savings plans for eligible employees. Expense related to these plans, including company matching contributions, was $18 million, $16 million and $15 million for fiscal years 2017, 2016 and 2015, respectively.