W. Pension and Other Postretirement Benefits

Alcoa maintains pension plans covering most U.S. employees and certain employees in foreign locations. Pension benefits generally depend on length of service, job grade, and remuneration. Substantially all benefits are paid through pension trusts that are sufficiently funded to ensure that all plans can pay benefits to retirees as they become due. Most salaried and non-bargaining hourly U.S. employees hired after March 1, 2006 participate in a defined contribution plan instead of a defined benefit plan.

Alcoa also maintains health care and life insurance benefit plans covering eligible U.S. retired employees and certain retirees from foreign locations. Generally, the medical plans pay a percentage of medical expenses, reduced by deductibles and other coverages. These plans are generally unfunded, except for certain benefits funded through a trust. Life benefits are generally provided by insurance contracts. Alcoa retains the right, subject to existing agreements, to change or eliminate these benefits. All salaried and certain non-bargaining hourly U.S. employees hired after January 1, 2002 and certain bargaining hourly U.S. employees hired after July 1, 2010 are not eligible for postretirement health care benefits. All salaried and certain hourly U.S. employees that retire on or after April 1, 2008 are not eligible for postretirement life insurance benefits.

The funded status of all of Alcoa’s pension and other postretirement benefit plans are measured as of December 31 each calendar year.

On June 24, 2010, the United Steelworkers ratified a new four-year labor agreement covering approximately 5,400 employees at 11 U.S. locations; the previous labor agreement expired on May 31, 2010. In 2010, as a result of the preparation for and ratification of the new agreement, Alcoa recognized $20 ($13 after-tax) in Cost of goods sold on the accompanying Statement of Consolidated Operations for strike preparation costs, a one-time signing bonus for employees, and an increase to pension net periodic benefit cost (see below). Additionally, as a result of the provisions of the new labor agreement, a significant plan amendment was adopted by one of Alcoa’s U.S. pension plans. Accordingly, this plan was required to be remeasured, and through this process, the discount rate was updated from 6.15% at December 31, 2009 to 5.95% at May 31, 2010. The plan remeasurement resulted in an increase to both Alcoa’s pension liability of $166 and the plan’s unrecognized net actuarial loss (included in other comprehensive loss) of $108 (after-tax). The plan remeasurement also resulted in an increase to 2010 net periodic benefit cost of $9.

Obligations and Funded Status


	Pension benefits						Other postretirement benefits
December 31,	2012			2011			2012			2011
Change in benefit obligation
Benefit obligation at beginning of year	$	13,526		$	12,343		$	2,844		$	2,902
Service cost		203			183			14			17
Interest cost		647			687			132			159
Amendments		6			40			-			(1	)
Actuarial losses		1,120			1,163			107			17
Settlements		-			(32	)		-			-
Curtailments		-			(7	)		-			-
Benefits paid, net of participants’ contributions		(833	)		(813	)		(256	)		(275	)
Medicare Part D subsidy receipts		-			-			21			25
Foreign currency translation impact		82			(38	)		1			-
Benefit obligation at end of year*	$	14,751		$	13,526		$	2,863		$	2,844
Change in plan assets
Fair value of plan assets at beginning of year	$	10,311		$	9,451		$	8		$	58
Actual return on plan assets		925			783			-			2
Employer contributions		571			945			-			-
Participants’ contributions		32			35			-			-
Benefits paid		(822	)		(805	)		(8	)		(52	)
Administrative expenses		(42	)		(38	)		-			-
Settlements		-			(34	)		-			-
Foreign currency translation impact		68			(26	)		-			-
Fair value of plan assets at end of year*	$	11,043		$	10,311		$	-		$	8
Funded status*	$	(3,708	)	$	(3,215	)	$	(2,863	)	$	(2,836	)
Less: Amounts attributed to joint venture partners		(40	)		(34	)		(4	)		(5	)
Net funded status	$	(3,668	)	$	(3,181	)	$	(2,859	)	$	(2,831	)
Amounts recognized in the Consolidated Balance Sheet consist of:
Noncurrent assets	$	86		$	109		$	-		$	-
Current liabilities		(32	)		(29	)		(256	)		(248	)
Noncurrent liabilities		(3,722	)		(3,261	)		(2,603	)		(2,583	)
Net amount recognized	$	(3,668	)	$	(3,181	)	$	(2,859	)	$	(2,831	)
Amounts recognized in Accumulated Other Comprehensive Loss consist of:
Net actuarial loss	$	5,880		$	5,191		$	593		$	511
Prior service cost (benefit)		119			129			(76	)		(92	)
Total, before tax effect		5,999			5,320			517			419
Less: Amounts attributed to joint venture partners		54			46			(1	)		(1	)
Net amount recognized, before tax effect	$	5,945		$	5,274		$	518		$	420
Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Loss consist of:
Net actuarial loss	$	1,073		$	1,216		$	107		$	17
Amortization of accumulated net actuarial loss		(384	)		(246	)		(25	)		(26	)
Prior service cost (benefit)		9			42			-			(1	)
Amortization of prior service (cost) benefit		(19	)		(19	)		16			17
Total, before tax effect		679			993			98			7
Less: Amounts attributed to joint venture partners		8			10			-			(1	)
Net amount recognized, before tax effect	$	671		$	983		$	98		$	8

At December 31, 2012, the benefit obligation, fair value of plan assets, and funded status for U.S. pension plans were $11,521, $8,437, and $(3,084), respectively. At December 31, 2011, the benefit obligation, fair value of plan assets, and funded status for U.S. pension plans were $10,702, $7,988, and $(2,714), respectively.

Pension Plan Benefit Obligations


	Pension benefits
	2012		2011
The projected benefit obligation and accumulated benefit obligation for all defined benefit pension plans was as follows:
Projected benefit obligation	$	14,751	$	13,526
Accumulated benefit obligation		14,186		13,025

The aggregate projected benefit obligation and fair value of plan assets for pension plans with projected benefit obligations in excess of plan assets was as follows:
Projected benefit obligation		13,973		12,828
Fair value of plan assets		10,142		9,470

The aggregate accumulated benefit obligation and fair value of plan assets for pension plans with accumulated benefit obligations in excess of plan assets was as follows:
Accumulated benefit obligation		13,421		12,184
Fair value of plan assets		10,123		9,281

Components of Net Periodic Benefit Cost


	Pension benefits⁽¹⁾									Other postretirement benefits⁽²⁾
	2012			2011			2010			2012			2011			2010
Service cost	$	186		$	165		$	148		$	14		$	17		$	20
Interest cost		639			678			682			131			158			174
Expected return on plan assets		(808	)		(806	)		(787	)		-			(2	)		(7	)
Recognized net actuarial loss		384			247			181			25			26			33
Amortization of prior service cost (benefit)		19			19			17			(16	)		(17	)		(15	)
Settlements⁽³⁾		-			2			2			-			-			(3	)
Curtailments⁽⁴⁾		-			(9	)		(10	)		-			-			-
Net periodic benefit cost⁽⁵⁾	$	420		$	296		$	233		$	154		$	182		$	202

⁽¹⁾	In 2012, 2011, and 2010, net periodic benefit cost for U.S pension plans was $288, $190, and $155, respectively.

⁽²⁾	In 2012, 2011, and 2010, net periodic benefit cost for other postretirement benefits reflects a reduction of $64, $43, and $39, respectively, related to the recognition of the federal subsidy awarded under Medicare Part D.

⁽³⁾	In all periods presented, settlements were due to the payment of significant lump sum benefits and/or purchases of annuity contracts.

⁽⁴⁾	In each period presented, curtailments were due to elimination of benefits or workforce reductions (see Note D).

⁽⁵⁾	Amounts attributed to joint venture partners are not included.

Amounts Expected to be Recognized in Net Periodic Benefit Cost


	Pension benefits		Other postretirement benefits
	2013		2013
Net actuarial loss recognition	$	494	$	36
Prior service cost (benefit) recognition		19		(18	)

Assumptions

Weighted average assumptions used to determine benefit obligations for U.S. pension and other postretirement benefit plans were as follows (assumptions for non-U.S plans did not differ materially):


December 31,	2012			2011
Discount rate		4.15	%		4.90	%
Rate of compensation increase		3.5			3.5

The discount rate is determined using a Company-specific yield curve model (above-median) developed with the assistance of an external actuary. The cash flows of the plans’ projected benefit obligations are discounted using a single equivalent rate derived from yields on high quality corporate bonds, which represent a broad diversification of issuers in various sectors, including finance and banking, manufacturing, transportation, insurance, and pharmaceutical, among others. The yield curve model parallels the plans’ projected cash flows, which have an average duration of 10 years, and the underlying cash flows of the bonds included in the model exceed the cash flows needed to satisfy the Company’s plans’ obligations multiple times.

The rate of compensation increase is based upon actual experience. For 2013, the rate of compensation increase will be 3.5%, which approximates the five-year average.

Weighted average assumptions used to determine net periodic benefit cost for U.S. pension and other postretirement benefit plans were as follows (assumptions for non-U.S plans did not differ materially):


	2012			2011			2010
Discount rate*		4.90	%		5.75	%		6.15	%
Expected long-term rate of return on plan assets		8.50			8.50			8.75
Rate of compensation increase		3.50			3.50			3.50

In all periods presented, the respective discount rates were used to determine net periodic benefit cost for most U.S. pension plans for the full annual period. However, the discount rates for a limited number of plans were updated during 2011 and 2010 to reflect the remeasurement of these plans due to new union labor agreements, settlements, and (or) curtailments. The updated discount rates used were not significantly different from the discount rates presented.

The expected long-term rate of return on plan assets is generally applied to a five-year market-related value of plan assets (a four-year average or the fair value at the plan measurement date is used for certain non-U.S. plans). The process used by management to develop this assumption has expanded from one that relied primarily on historical asset return information to one that also incorporates forward-looking returns by asset class, as described below.

Prior to developing the expected long-term rate of return for calendar year 2009, management focused on historical actual returns (annual, 10-year moving, and 20-year moving averages) when developing this assumption. Based on that process, management utilized 9% for the expected long-term rate of return for several years through 2008. For calendar year 2009, the expected long-term rate of return was reduced to 8.75% due to lower future expected market returns as a result of the then global economic downturn. This was supported by the fact that, in 2008, the 10-year moving average of actual performance fell below 9% for the first time in 20 years, although the 20-year moving average continued to exceed 9%.

For calendar year 2010, management expanded its process by incorporating expected future returns on current and planned asset allocations using information from various external investment managers and management’s own judgment. Management considered this forward-looking analysis as well as the historical return information, and concluded the expected rate of return for calendar 2010 would remain at 8.75%, which was between the 20-year moving average actual return performance and the estimated future return developed by asset class.

For calendar year 2012 and 2011, management again incorporated both actual historical return information and expected future returns into its analysis. Based on strategic asset allocation changes and estimates of future returns by asset class, management used 8.50% as its expected long-term rate of return for both years. This rate again falls within the range of the 20-year moving average of actual performance and the expected future return developed by asset class.

For calendar year 2013, management used the same methodology as it did for 2012 and 2011 and determined that 8.50% will be the expected long-term rate of return.

Assumed health care cost trend rates for U.S. other postretirement benefit plans were as follows (assumptions for non-U.S plans did not differ materially):


	2012			2011			2010
Health care cost trend rate assumed for next year		6.0	%		6.5	%		6.5	%
Rate to which the cost trend rate gradually declines		4.5	%		5.0	%		5.0	%
Year that the rate reaches the rate at which it is assumed to remain		2017			2016			2015

The assumed health care cost trend rate is used to measure the expected cost of gross eligible charges covered by Alcoa’s other postretirement benefit plans. For 2013, a 6.0% trend rate will be used, reflecting management’s best estimate of the change in future health care costs covered by the plans. The plans’ actual annual health care cost trend experience over the past three years has ranged from (6.2)% to 3.8%. Management does not believe this three-year range is indicative of expected increases for future health care costs over the long-term.

Assumed health care cost trend rates have an effect on the amounts reported for the health care plan. A one-percentage point change in these assumed rates would have the following effects:


	1% increase		1% decrease
Effect on other postretirement benefit obligations	$	124	$	(114	)
Effect on total of service and interest cost components		5		(5	)

Plan Assets

Alcoa’s pension and other postretirement plans’ investment policy and weighted average asset allocations at December 31, 2012 and 2011, by asset class, were as follows:


				Plan assets at December 31,
Asset class	Policy range			2012			2011
Equities		20–55	%		33	%		34	%
Fixed income		25–55	%		50			50
Other investments		15–35	%		17			16
Total					100	%		100	%

The principal objectives underlying the investment of the pension and other postretirement plans’ assets are to ensure that Alcoa can properly fund benefit obligations as they become due under a broad range of potential economic and financial scenarios, maximize the long-term investment return with an acceptable level of risk based on such obligations, and broadly diversify investments across and within the capital markets to protect asset values against adverse movements. Specific objectives for long-term investment strategy include reducing the volatility of pension assets relative to pension liabilities and achieving risk factor diversification across the balance of the asset portfolio. A portion of the assets are matched to the interest rate profile of the benefit obligation through long duration fixed income investments and exposure to broad equity risk has been decreased and diversified through investments in macro hedge funds, equity long and short hedge funds, global and emerging market equities, and gold. Investments are further diversified by strategy, asset class, geography, and sector to enhance returns and mitigate downside risk. A large number of external investment managers are used to gain broad exposure to the financial markets and to mitigate manager-concentration risk.

Investment practices comply with the requirements of the Employee Retirement Income Security Act of 1974 (ERISA) and any other applicable laws and regulations. The use of derivative instruments is permitted where appropriate and necessary for achieving overall investment policy objectives. Currently, the use of derivative instruments is not significant when compared to the overall investment portfolio.

In the course of managing the pension and other postretirement plans’ assets, trustees of the plans loan securities to brokers/dealers in exchange for a fee. The securities are subsequently returned to the plans in accordance with the brokerage agreement. In support of these transactions, the brokers/dealers provide collateral, which exceeds the value of the securities loaned (102%-105%).

The following section describes the valuation methodologies used by the trustees to measure the fair value of pension and other postretirement benefit plan assets, including an indication of the level in the fair value hierarchy in which each type of asset is generally classified (see Note X for the definition of fair value and a description of the fair value hierarchy).

Equities. These securities consist of direct investments in the stock of publicly traded U.S. and non-U.S. companies and are valued based on the closing price reported in an active market on which the individual securities are traded. As such, the direct investments are generally classified in Level 1. Also, these securities consist of the plans’ share of commingled funds that are invested in the stock of publicly traded companies and are valued at the net asset value of shares held at December 31. As such, these securities are included in Level 1 if quoted in an active market, otherwise these investments are included in Level 2. Additionally, these securities include direct investments in short and long equity hedge funds and private equity (limited partnerships and venture capital partnerships) and are valued by investment managers based on the most recent financial information available, which typically represents significant unobservable data. As such, these investments are generally classified as Level 3.

Fixed income. These securities consist of U.S. government debt and are generally valued using quoted prices. As such, these securities are included in Level 1. Also, these securities include publicly traded U.S. and non-U.S. fixed interest obligations (principally corporate bonds and debentures) and are valued through consultation and evaluation with brokers in the institutional market using quoted prices and other observable market data. As such, these investments are included in Level 2. Additionally, these securities include cash and cash equivalents, which consist of government securities in commingled funds, and are generally valued using observable market data. As such, these funds are included in Level 2. Furthermore, these securities consist of commercial and residential mortgage-backed securities and are valued by investment managers based on the most recent financial information available, which typically represents significant unobservable data. As such, these investments are generally classified as Level 3.

Other investments. These investments include, among others, exchange traded funds, macro hedge funds, real estate investment trusts, and direct investments of private real estate. Exchange traded funds, such as gold, and real estate investment trusts are valued based on the closing price reported in an active market on which the investments are traded, and, therefore, are included in Level 1. Also, these securities consist of the plans’ share of commingled funds that are invested in real estate investment trusts and are valued at the net asset value of shares held at December 31. As such, these securities are generally included in Level 2. Direct investments of macro hedge funds and private real estate (includes limited partnerships) are valued by investment managers based on the most recent financial information available, which typically represents significant unobservable data. As such, these investments are generally classified as Level 3. If fair value is able to be determined through the use of quoted market prices of similar assets or other observable market data, then the investments are classified in Level 2.

The fair value methods described above may not be indicative of net realizable value or reflective of future fair values. Additionally, while Alcoa believes the valuation methods used by the plans’ trustees 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 following table presents the fair value of pension and other postretirement plans’ assets classified under the appropriate level of the fair value hierarchy:


December 31, 2012	Level 1		Level 2		Level 3		Total
Equities:
Equity securities	$	1,016	$	1,196	$	117	$	2,329
Short and long equity hedge funds		-		-		756		756
Private equity		-		-		550		550
	$	1,016	$	1,196	$	1,423	$	3,635
Fixed income:
Intermediate and long duration government/credit	$	1,169	$	3,689	$	215	$	5,073
Other		-		507		-		507
	$	1,169	$	4,196	$	215	$	5,580
Other investments:
Real estate	$	113	$	83	$	377	$	573
Macro hedge funds		-		-		796		796
Other		212		-		247		459
	$	325	$	83	$	1,420	$	1,828
Total	$	2,510	$	5,475	$	3,058	$	11,043

December 31, 2011	Level 1		Level 2		Level 3		Total
Equities
Equity securities*	$	904	$	1,203	$	110	$	2,217
Short and long equity hedge funds		-		-		731		731
Private equity		-		-		542		542
	$	904	$	1,203	$	1,383	$	3,490
Fixed income:
Intermediate and long duration government/credit	$	1,223	$	3,540	$	211	$	4,974
Other		-		340		-		340
	$	1,223	$	3,880	$	211	$	5,314
Other investments:
Real estate	$	97	$	74	$	375	$	546
Macro hedge funds		-		-		668		668
Other		198		-		123		321
	$	295	$	74	$	1,166	$	1,535
Total**	$	2,422	$	5,157	$	2,760	$	10,339

*	At December 31, 2011, Level 1 equity securities include $36 of Alcoa common stock related to the January 2011 plan contribution (see Funding and Cash Flows section below).

**	As of December 31, 2011, the total fair value of pension and other postretirement plans’ assets excludes a net payable of $20, which represents securities purchased not yet settled less interest and dividends earned on various investments.

Pension and other postretirement benefit plans’ assets classified as Level 3 in the fair value hierarchy represent investments in which the trustees have used significant unobservable inputs in the valuation model. The following table presents a reconciliation of activity for such investments:


	2012			2011
Balance at beginning of year	$	2,760		$	1,499
Realized gains		52			67
Unrealized gains		142			100
Purchases		634			1,221
Sales		(538	)		(124	)
Issuances		-			-
Settlements		-			-
Foreign currency translation impact		8			(3	)
Transfers in and (or) out of Level 3*		-			-
Balance at end of year	$	3,058		$	2,760

*	In 2012 and 2011, there were no transfers of financial instruments into or out of Level 3

Funding and Cash Flows

It is Alcoa’s policy to fund amounts for pension plans sufficient to meet the minimum requirements set forth in applicable country benefits laws and tax laws, including the Pension Protection Act of 2006, the Worker, Retiree, and Employer Recovery Act of 2008, and the Moving Ahead for Progress in the 21^st Century Act for U.S. plans. From time to time, Alcoa contributes additional amounts as deemed appropriate. In 2012 and 2011, cash contributions to Alcoa’s pension plans were $561 and $336. Also in 2011, Alcoa contributed newly issued shares (see Note R) of its common stock (valued at $600) to a master trust that holds the assets of certain U.S. defined benefit pension plans in a private placement transaction. These shares were issued to satisfy the estimated minimum required funding and to provide additional funding towards maintaining an approximately 80% funded status of Alcoa’s U.S. pension plans. The minimum required contribution to pension plans in 2013 is estimated to be $460, of which $140 is for non-U.S. plans.

Benefit payments expected to be paid to pension and other postretirement benefit plans’ participants and expected Medicare Part D subsidy receipts are as follows:


Year ended December 31,	Pension benefits		Gross Other post- retirement benefits		Medicare Part D subsidy receipts		Net Other post- retirement benefits
2013	$	880	$	285	$	30	$	255
2014		870		280		30		250
2015		880		280		30		250
2016		890		275		30		245
2017		910		270		35		235
2018 through 2022		4,620		1,200		170		1,030
	$	9,050	$	2,590	$	325	$	2,265

Defined Contribution Plans

Alcoa sponsors savings and investment plans in several countries, including the U.S. and Australia. Expenses related to these plans were $146 in 2012, $139 in 2011, and $119 in 2010. In the U.S., employees may contribute a portion of their compensation to the plans, and Alcoa matches, mostly in company stock, a portion of these contributions.