BENEFIT PLANS

Pension and Other Postretirement Benefits

We sponsor four defined benefit pension plans, one qualified plan and three nonqualified plans, which are described below.

•

The funded qualified employee retirement plan provides benefits to all eligible employees. Benefits are determined based on final average salary and years of service through December 31, 2010, and a cash balance account based formula for service beginning January 1, 2011. Although our funded employee retirement plan fully meets all of the funding requirements under applicable laws and regulations, during 2011 and 2010 we voluntarily contributed $48 million and $34 million, respectively, to improve the plan’s funded status.


•	The unfunded nonqualified restoration retirement plan provides for the restoration of retirement benefits to certain senior level employees that are not provided under the qualified retirement plan due to limits imposed by the Internal Revenue Code.


•	The unfunded nonqualified executive security plan provides certain executive officers and other key personnel with supplemental pension benefits. These benefits are provided by a nonqualified, noncontributory plan and are based on years of service and compensation. We made payments of $11 million and $30 million during 2011 and 2010, respectively, for current retiree obligations under the plan.


•	The unfunded nonqualified supplemental executive retirement plan provides eligible senior level executives a supplemental pension benefit in excess of those earned under the qualified retirement plan. This plan was approved and adopted by the Compensation Committee on January 12, 2011.

Tesoro provides health care benefits to retirees who met certain service requirements and were participating in our group health insurance program at retirement. In addition, Tesoro sponsors two 401(k) plans, the thrift plan and the retail savings plan, both of which provide for eligible employees to make contributions, subject to certain limitations, into designated investment funds with a matching contribution by Tesoro.

Investment Policies and Strategies

Our funded qualified retirement plan assets are invested using a total return investment approach (including dividends, interest, and realized and unrealized capital appreciation) whereby a mix of equity securities, fixed income securities and other investments are used to preserve asset values, diversify risk and achieve our target investment return. Plan assets are managed in a diversified portfolio comprised of two primary components: an equity portion and a fixed income portion. The expected role of the plan’s equity investments is to maximize the long-term real growth of plan assets, while the role of fixed income investments are to generate current income, lower funded status volatility, provide for more stable periodic returns and provide protection against a prolonged decline in the equity markets. Investment strategies and asset allocation decisions are based on careful consideration of risk tolerance, plan liabilities, the plan’s funded status and our financial condition.

Our target allocation is as follows: 50% long duration fixed income, 30% equity and 20% other investments comprised primarily of assets which provide protection in inflationary periods and investments which target a return regardless of market conditions.

Fair Value of Plan Assets

We classify our plan assets into three fair value classifications or levels. Our level 1 investments include mutual funds, which are based on market quotations from national securities exchanges. Level 2 investments include common collective trust funds and equity and bond securities, valued at the last reported sales price or closing price as reported by an independent pricing service. When market prices are not readily available, the determination of fair value may rely on factors such as significant market activity or security specific events, changes in interest rates and credit quality, and developments in foreign markets. We did not hold any level 3 assets in our investments as of December 31, 2011 and 2010. We do not believe that there are any significant concentrations of risk within our plan assets.

The tables below present information about the retirement plan’s major asset categories measured at fair value on a recurring basis by the three levels described above as of December 31, 2011 and 2010 (in millions):



Asset Category	December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash and cash equivalents (a)	$	16	$	—	$	16	$	—
Equities (b):
U.S. equity funds (domestic)	23		12		11		—
International equity funds (non-U.S.)	25		—		25		—
Global equity funds (domestic and non-U.S.)	42		—		42		—
Fixed income long duration bonds (c)	174		—		174		—
Other (d):
Real return funds	31		31		—		—
Absolute return funds	32		32		—		—
Total	$	343	$	75	$	268	$	—



Asset Category	December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash and cash equivalents (a)	$	18	$	—	$	18	$	—
Equities (b):
U.S. equity funds (domestic) (e)	94		52		42		—
International equity funds (non-U.S.)	39		—		39		—
Fixed income long duration bonds (c)	128		—		128		—
Other (d):
Real return funds	15		15		—		—
Absolute return funds	—		—		—		—
Total	$	294	$	67	$	227	$	—

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(a)	Cash and cash equivalents consist of cash on hand and a short-term investment fund. The short-term investment fund provides for safety of principal and daily liquidity and is valued using the net asset value (NAV) per share. These assets are classified as Level 2 investments.


(b)	Equities consist of mutual funds and commingled investment funds that invest in equity securities. Commingled fund values reflect the net asset value per share, derived from the quoted prices in active markets of the underlying securities. Mutual funds are classified as Level 1 investments; commingled funds are classified as Level 2 investments.

(c)

Fixed income assets represent securities primarily invested in corporate, government related, mortgage and asset backed securities with a focus on long duration issues. Individual fixed income securities are generally priced on the basis of evaluated prices from independent pricing services. Such prices are monitored and provided by an independent, third-party custodial firm responsible for safekeeping plan assets. All fixed income securities are classified as Level 2 investments.


(d)	Other assets consist of investments in mutual funds that invest in a broad set of asset classes designed to provide the potential for real returns in excess of U.S. inflation or a target return regardless of market conditions. These assets are categorized as Level 1 investments.


(e)	We have presented prior year U.S. large cap and U.S. small/mid cap asset categories in U.S. equity funds (domestic) asset category in order to conform to current year presentation.

Pension and Other Postretirement Financial Information

We recognize separately the overfunded or underfunded status of our pension and other postretirement plans as an asset or liability. The funded status represents the difference between the projected benefit obligation and the fair value of the plan assets. The projected benefit obligation is the present value of benefits earned to date by plan participants, including the effect of assumed future salary increases. Plan assets are measured at fair value. We use a December 31^st measurement date for plan assets and obligations for all our retirement plans.

Changes in our projected benefit obligations and plan assets, and the funded status for our pension plans and other postretirement benefits as of December 31, 2011 and 2010, were (in millions):



	Pension Benefits						Other Postretirement Benefits
	2011			2010			2011			2010
Change in projected benefit obligation:
Projected benefit obligations at beginning of year	$	564		$	511		$	96		$	356
Service cost	27			39			5			11
Interest cost	30			27			4			14
Actuarial loss	47			45			5			85
Benefits paid	(38		)	(62		)	(7		)	(6		)
Plan amendments	—			—			(3		)	(317		)
Curtailments	—			4			—			(47		)
Projected benefit obligation at end of year	630			564			100			96

Changes in plan assets:
Fair value of plan assets at beginning of year	294			262			—			—
Actual return on plan assets	28			30			—			—
Employer contributions	59			64			7			6
Benefits paid	(38		)	(62		)	(7		)	(6		)
Fair value of plan assets at end of year	343			294			—			—
Funded status at end of year	$	(287	)	$	(270	)	$	(100	)	$	(96	)

The accumulated benefit obligation is the present value of benefits earned to date, assuming no future salary growth. The accumulated benefit obligation for our pension plans at December 31, 2011 and 2010, was $480 million and $431 million, respectively. Liability amounts recognized in our consolidated balance sheet related to our defined benefit pension plans and other postretirement benefits as of December 31, 2011 and 2010, consisted of (in millions):



	Pension Benefits				Other Postretirement Benefits
	2011		2010		2011		2010
Accrued liabilities	$	2	$	8	$	10	$	8
Other noncurrent liabilities	285		262		90		88
Total amount recognized	$	287	$	270	$	100	$	96

The components of pension and postretirement net periodic benefit expense (income) included in the consolidated statements of operations for the years ended December 31, 2011, 2010 and 2009, were (in millions):



	Pension Benefits									Other Postretirement Benefits
	2011			2010			2009			2011			2010			2009
Components of net periodic benefit expense (income):
Service cost	$	27		$	39		$	36		$	5		$	11		$	16
Interest cost	30			27			27			4			14			20
Expected return on plan assets	(21		)	(22		)	(21		)	—			—			—
Amortization of prior service cost (credit)	1			3			4			(37		)	(18		)	1
Recognized net actuarial loss	20			14			15			12			7			1
Recognized curtailment loss (gain)	4			4			—			—			(48		)	—
Net Periodic Benefit Expense (Income)	$	61		$	65		$	61		$	(16	)	$	(34	)	$	38

Amounts recognized in accumulated other comprehensive loss before income taxes as of December 31, 2011 and 2010, consisted of (in millions):



	Pension Benefits				Other Postretirement Benefits						Total
	2011		2010		2011			2010			2011			2010
Net loss	$	264	$	247	$	114		$	122		$	378		$	369
Prior service cost (credit)	4		7		(259		)	(294		)	(255		)	(287		)
Total	$	268	$	254	$	(145	)	$	(172	)	$	123		$	82

The following table summarizes amounts recognized in other comprehensive income (loss) before income taxes for the years ended December 31, 2011, 2010 and 2009 (in millions):



	Pension Benefits									Other Postretirement Benefits
	2011			2010			2009			2011			2010			2009
Net gain (loss) arising during the year:
Net actuarial gain (loss)	$	(39	)	$	(41	)	$	(17	)	$	(4	)	$	(39	)	$	29
Prior service credit	—			—			—			2			317			—
Net gain reclassified into income:
Net actuarial loss (gain)	22			15			15			12			(42		)	1
Prior service cost (credit)	3			5			4			(37		)	(17		)	1
Total recognized in other comprehensive income (loss)	$	(14	)	$	(21	)	$	2		$	(27	)	$	219		$	31

Amounts included in accumulated other comprehensive loss before income taxes as of December 31, 2011, that are expected to be recognized as components of net periodic benefit expense in 2012 are as follows (in millions):



	Pension Benefits		Other Postretirement Benefits			Total
Net loss	$	22	$	11		$	33
Prior service cost (credit)	1		(38		)	(37		)
Total	$	23	$	(27	)	$	(4	)

Assumptions

The following weighted-average assumptions were used to determine benefit obligations and net periodic benefit expenses for the years ended December 31, 2011, 2010 and 2009:



	Pension Benefits						Other Postretirement Benefits
	2011		2010		2009		2011		2010		2009
Projected benefit obligation:
Discount rate (a)	4.86	%	5.55	%	5.80	%	3.76	%	4.38	%	6.36	%
Rate of compensation increase	4.50	%	4.50	%	4.57	%	—		—		—
Net periodic benefit expense:
Discount rate (a)(b)	5.55	%	5.80	%	6.28	%	4.38	%	5.50	%	6.14	%
Rate of compensation increase	4.50	%	4.57	%	4.59	%	—		—		—
Expected long-term return on plan assets (c)	7.25	%	7.50	%	8.50	%	—		—		—

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(a)	We determine the discount rate primarily by reference to the effective yields on high quality corporate bonds that have a comparable cash flow pattern to the expected payments to be made under our plans.


(b)	As a result of the changes to other postretirement benefits during the second quarter of 2010, we remeasured our postretirement obligation as of June 30, 2010. The discount rate used to determine the net periodic benefit expense was 6.36% for the six months ended June 30, 2010, and 4.64% for the six months ended December 31, 2010.


(c)	The expected return on plan assets reflects the weighted-average of the expected long-term rates of return for the broad categories of investments held in the plans. The expected long-term rate of return is adjusted when there are fundamental changes in expected returns on the plan’s investments.

The assumed health care cost trend rates used to determine the projected postretirement benefit obligation are as follows:



	2011		2010
Health care cost trend rate assumed for next year	8.00	%	8.50	%
Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)	4.80	%	4.50	%
Year that the rate reaches the ultimate trend rate	2024		2018

Assumed health care cost trend rates could have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects (in millions):



	1-Percentage-Point Increase		1-Percentage-Point Decrease
Effect on total of service and interest cost components	$	0.2	$	(0.2	)
Effect on postretirement benefit obligation	1		(1		)

Future Cash Flows

Tesoro has no minimum required contribution obligation to its funded employee pension plan under applicable laws and regulations in 2012 and we continue to evaluate our expected 2012 voluntary contributions.

The following estimated future benefit payments, which reflect expected future service, as appropriate, are expected to be paid for our defined benefit pension plans and other postretirement benefits in the years indicated (in millions):



	Pension Benefits		Other Postretirement Benefits
2012	$	49	$	10
2013	48		12
2014	51		10
2015	56		10
2016	58		11
2017-2021	321		53

Thrift Plan

We sponsor an employee thrift 401(k) plan that provides for contributions, subject to certain limitations, by eligible employees into designated investment funds with a matching contribution by Tesoro. Employees may elect tax-deferred treatment in accordance with the provisions of Section 401(k) of the Internal Revenue Code. We match 100% of employee contributions, up to 6% of the employee's eligible compensation (subject to applicable union collective bargaining agreements). Effective in August 2011, we eliminated the requirement that 50% of Tesoro's matching contribution to employees be invested in Tesoro's common stock held in the Tesoro common stock fund, and began allowing employees the ability to invest their own contributions in the Tesoro common stock fund. Our contributions to the thrift plan amounted to $19 million, $24 million and $24 million for each of the years in 2011, 2010 and 2009, respectively, of which $13 million and $8 million consisted of treasury stock reissuances in 2010 and 2009, respectively. Treasury stock reissuances were not used to fund contributions during 2011.

We also sponsor a non-qualified executive deferred compensation plan, which provides eligible employees the opportunity for additional pre-tax deferrals and company contributions not provided under thrift 401(k) plan due to compensation and deferral limitations imposed under Internal Revenue Code.

Retail Savings Plan

We sponsor a separate 401(k) savings plan for eligible retail store employees who meet the plan's eligibility requirements. Eligible employees automatically receive a non-elective employer contribution equal to 3% of eligible earnings, regardless of participation. For employees that make pre-tax contributions, we also provide a matching contribution equal to $0.50 for each $1.00 of employee contributions, up to 6% of eligible earnings. Effective in August 2011, we eliminated the requirement that 50% of Tesoro's matching contribution to employees be invested in Tesoro's common stock held in the Tesoro common stock fund, and began allowing employees the ability to invest their own contributions in the Tesoro common stock fund. Our contributions amounted to $0.7 million, $0.1 million and $0.6 million in 2011, 2010 and 2009, respectively, of which $0.1 million consisted of treasury stock reissuances in both 2010 and 2009. Treasury stock reissuances were not used to fund contributions during 2011. Beginning with the 2010 plan year, non-elective Company contributions are made in one payment after the end of the plan year.