14. 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. In December 2011, the Compensation and Benefits Committee of the Company’s Board of Directors approved management’s proposal to change Merck’s primary U.S. defined benefit pension plans’ benefit formulas to “cash balance” formulas beginning for service on or after January 1, 2013. Active participants in these plans as of December 31, 2012 are accruing pension benefits prospectively using the 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. In December 2011, the Company approved changes to its U.S. retiree healthcare plans, including changes for certain employees to the contribution subsidy level and eligibility criteria for subsidized retiree medical coverage and the elimination of certain retiree dental coverage.

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	2012			2011			2010			2012			2011			2010
Service cost	$	555		$	619		$	584		$	82		$	110		$	108
Interest cost		661			718			688			121			141			148
Expected return on plan assets		(970	)		(972	)		(891	)		(136	)		(142	)		(132	)
Net amortization		185			201			148			(35	)		(17	)		8
Termination benefits		27			59			54			18			29			42
Curtailments		(10	)		(86	)		(50	)		(7	)		1			(10	)
Settlements		18			4			(1	)		—			—			—

Net periodic benefit cost	$	466		$	543		$	532		$	43		$	122		$	164

The decline in net periodic benefit cost for pension and other postretirement benefit plans in 2012 as compared with 2011 and 2010 is largely attributable to the benefit plan design changes discussed above. The changes to Merck’s primary U.S. defined benefit pension plans and U.S. retiree healthcare plans reduced benefit obligations at December 31, 2011 by $752 million and $150 million, respectively, with a corresponding offset to AOCI, which is being amortized as reduction to net periodic benefit cost over the employees’ future service period (approximately 11 years).

The net periodic benefit cost attributable to U.S. pension plans included in the above table was $268 million in 2012, $406 million in 2011 and $289 million in 2010.

In connection with restructuring actions (see Note 3), termination charges were recorded in 2012, 2011 and 2010 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 2012, 2011 and 2010 on pension and other postretirement benefit plans.

In addition, settlements were recorded in 2012, 2011 and 2010 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
	2012			2011			2012			2011
Fair value of plan assets January 1	$	12,481		$	12,705		$	1,628		$	1,685
Actual return on plan assets		1,739			6			200			(20	)
Company contributions		1,853			556			48			58
Mergers, acquisitions and divestitures		—			(202	)		—			—
Effects of exchange rate changes		3			56			—			—
Benefits paid		(673	)		(581	)		(115	)		(95	)
Settlements		(75	)		(78	)		—			—
Other		21			19			(1	)		—

Fair value of plan assets December 31	$	15,349		$	12,481		$	1,760		$	1,628

Benefit obligation January 1		14,416			13,978			2,529			2,745
Service cost		555			619			82			110
Interest cost		661			718			121			141
Mergers, acquisitions and divestitures		—			(180	)		—			—
Actuarial losses (gains)		2,660			688			88			(266	)
Benefits paid		(673	)		(581	)		(115	)		(95	)
Effects of exchange rate changes		67			53			—			(3	)
Plan amendments		2			(763	)		(86	)		(150	)
Curtailments		(17	)		(150	)		1			16
Termination benefits		27			59			18			29
Settlements		(75	)		(78	)		—			—
Other		23			53			12			2

Benefit obligation December 31	$	17,646		$	14,416		$	2,650		$	2,529

Funded status December 31	$	(2,297	)	$	(1,935	)	$	(890	)	$	(901	)

Recognized as:
Other assets	$	355		$	669		$	506		$	391
Accrued and other current liabilities		(50	)		(81	)		(9	)		(10	)
Deferred income taxes and noncurrent liabilities		(2,602	)		(2,523	)		(1,387	)		(1,282	)

The fair value of U.S. pension plan assets included in the preceding table was $8.7 billion and $6.8 billion at December 31, 2012 and 2011, respectively, and the projected benefit obligation of U.S. pension plans was $10.0 billion and $8.7 billion, respectively. Approximately 44% and 40% of the Company’s pension projected benefit obligation at December 31, 2012 and 2011, 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, 2012 and 2011, the accumulated benefit obligation was $15.9 billion and $12.9 billion, respectively, for all pension plans, of which $9.0 billion and $7.8 billion, respectively, related to U.S. pension plans.

For pension plans with projected benefit obligations in excess of plan assets at December 31, 2012 and 2011, the fair value of plan assets was $12.8 billion and $9.3 billion, respectively, and the benefit obligations were $15.5 billion and $11.9 billion, respectively. For those plans with accumulated benefit obligations in excess of plan assets at December 31, 2012 and 2011, the fair value of plan assets was $6.1 billion and $3.6 billion, respectively, and the accumulated benefit obligations were $7.7 billion and $5.4 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, 2012 and 2011, $692 million and $637 million, respectively, or approximately 5% 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
	2012								2011
Assets
Cash and cash equivalents	$	142	$	587	$	—	$	729	$	93	$	217	$	—	$	310
Investment funds
U.S. large cap equities		63		2,899		—		2,962		65		2,226		—		2,291
U.S. small/mid cap equities		10		954		—		964		9		710		—		719
Non-U.S. developed markets equities		610		2,133		—		2,743		390		1,735		—		2,125
Non-U.S. emerging markets equities		121		771		—		892		82		575		—		657
Government and agency obligations		279		720		—		999		119		632		—		751
Corporate obligations		166		94		—		260		112		193		—		305
Fixed income obligations		14		206		—		220		—		144		—		144
Real estate ⁽¹⁾		4		14		141		159		—		9		144		153
Equity securities
U.S. large cap		351		—		—		351		330		—		—		330
U.S. small/mid cap		1,258		—		—		1,258		1,085		—		—		1,085
Non-U.S. developed markets		668		—		—		668		623		—		—		623
Fixed income securities
Government and agency obligations		2		1,052		—		1,054		—		1,248		—		1,248
Corporate obligations		—		1,008		—		1,008		—		703		—		703
Mortgage and asset-backed securities		—		269		—		269		—		275		—		275
Other investments
Insurance contracts ⁽²⁾		—		117		496		613		—		138		428		566
Derivatives		—		162		—		162		—		141		—		141
Other				53		55		108		3		42		65		110

Liabilities
Derivatives	$	—		70	$	—		70	$	—	$	55	$	—	$	55

	$	3,688	$	10,969	$	692	$	15,349	$	2,911	$	8,933	$	637	$	12,481

⁽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:


	2012								2011
	Insurance Contracts		Real Estate		Other		Total		Insurance Contracts			Real Estate			Other			Total
Balance January 1		428		144		65	$	637	$	420		$	165		$	63		$	648
Actual return on plan assets:
Relating to assets still held at December 31		35		20		(2)		53		16			(7	)		(2	)		7
Relating to assets sold during the year		1		(12)		5		(6)		1			—			4			5
Purchases		21		-		4		25		19			13			(3	)		29
Sales		(11)		(1)		(14)		(26)		(28	)		(27	)		3			(52	)
Transfers to Level 3		22		(10)		(3)		9		—			—			—			—

Balance December 31	$	496	$	141	$	55	$	692	$	428		$	144		$	65		$	637

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
	2012								2011
Assets
Cash and cash equivalents	$	27	$	48	$	—	$	75	$	28	$	40	$	—	$	68
Investment funds
U.S. large cap equities		—		275		—		275		—		443		—		443
U.S. small/mid cap equities		—		150		—		150		—		286		—		286
Non-U.S. developed markets equities		37		76		—		113		60		101		—		161
Non-U.S. emerging markets equities		37		75		—		112		30		65		—		95
Fixed income obligations		3		23		—		26		—		34		—		34
Equity securities
U.S. large cap		6		—		—		6		4		—		—		4
U.S. small/mid cap		101		—		—		101		101		—		—		101
Non-U.S. developed markets		32		—		—		32		94		—		—		94
Fixed income securities
Government and agency obligations		—		298		—		298		—		76		—		76
Corporate obligations		—		310		—		310		—		208		—		208
Mortgage and asset-backed securities		—		238		—		238		—		46		—		46
Other fixed income obligations		—		24		—		24		—		12		—		12

	$	243	$	1,517	$	—	$	1,760	$	317	$	1,311	$	—	$	1,628

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 45% to 60% in U.S. equities, 20% to 30% in international equities, 15% to 25% in fixed-income investments, and up to 8% 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 2013 are expected to be approximately $340 million and $40 million, respectively.

Expected Benefit Payments

Expected benefit payments are as follows:


	Pension Benefits		Other Postretirement Benefits
2013	$	643	$	123
2014		636		128
2015		693		133
2016		713		138
2017		742		143
2018 - 2022		4,566		802

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	2012			2011			2010		2012			2011			2010
Net (loss) gain arising during the period	$	(1,907	)	$	(1,628	)	$	361	$	(24	)	$	106		$	66
Prior service (cost) credit arising during the period		(13	)		783			1		78			133			99

	$	(1,920	)	$	(845	)	$	362	$	54		$	239		$	165

Net loss amortization included in benefit cost	$	256		$	196		$	140	$	31		$	38		$	55
Prior service (credit) cost amortization included in benefit cost		(71	)		5			8		(66	)		(55	)		(47	)

	$	185		$	201		$	148	$	(35	)	$	(17	)	$	8

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 2013 are $410 million and $(72) million, respectively, for pension plans and are $25 million and $(73) 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	2012			2011			2010			2012			2011			2010
Net periodic benefit cost
Discount rate		4.70	%		5.20	%		5.50	%		4.80	%		5.40	%		5.90	%
Expected rate of return on plan assets		7.50	%		7.50	%		7.60	%		8.70	%		8.70	%		8.70	%
Salary growth rate		4.00	%		4.20	%		4.15	%		4.50	%		4.50	%		4.50	%

Benefit obligation
Discount rate		3.90	%		4.70	%		5.20	%		4.10	%		4.80	%		5.40	%
Salary growth rate		4.20	%		4.00	%		4.20	%		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 country basis. In developing the expected rate of return within each country, 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 country’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 2013, the Company’s expected rate of return will range from 6.00% to 8.75% compared to a range of 5.75% to 8.75% in 2012 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	2012			2011
Health care cost trend rate assumed for next year		7.5	%		7.9	%
Rate to which the cost trend rate is assumed to decline		5.0	%		5.0	%
Year that the trend rate reaches the ultimate trend rate		2018			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	$	396	$	(324	)

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 2012, 2011 and 2010 were $146 million, $166 million and $155 million, respectively.