PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS

We have noncontributory union, non-union and combined retiree defined benefit pension plans covering eligible employees. The combined retiree defined benefit pension plan was created on January 1, 2016, to include all union and non-union retirees from the existing plans as of January 1, 2016. The plans provide defined benefits based on years of service and final average pay. We contributed $6.3 million in cash to the plans in 2016 (none in 2015; $19.5 million of ALLETE common stock in 2014). On January 13, 2017, we contributed $1.7 million in cash to the plans, and on January 17, 2017, we contributed $13.5 million of ALLETE common stock to the plans. We also have a defined contribution RSOP covering substantially all employees. The 2016 plan year employer contributions, which are made through the employee stock ownership plan portion of the RSOP, totaled $9.2 million ($9.0 million for the 2015 plan year; $9.1 million for the 2014 plan year). (See Note 12. Common Stock and Earnings Per Share and Note 16. Employee Stock and Incentive Plans.)

In 2006, the non-union defined benefit pension plan was amended to suspend further crediting of service to the plan and to close the plan to new participants. In conjunction with those amendments, contributions were increased to the RSOP. In 2010, the Minnesota Power union defined benefit pension plan was amended to close the plan to new participants beginning February 1, 2011.

NOTE 15. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS (Continued)

We have postretirement health care and life insurance plans covering eligible employees. In 2010, our postretirement health plan was amended to close the plan to employees hired after January 31, 2011. The full eligibility requirement was also amended in 2010, to require employees to be at least age 55 with 10 years of participation in the plan. In 2014, our postretirement life plan was amended to close the plan to non-union employees retiring after December 31, 2015. The postretirement health and life plans are contributory with participant contributions adjusted annually. Postretirement health and life benefits are funded through a combination of Voluntary Employee Benefit Association trusts (VEBAs), established under section 501(c)(9) of the Internal Revenue Code, and irrevocable grantor trusts. In 2016, no contributions were made to the VEBAs (none in 2015; none in 2014) and no contributions were made to the grantor trusts (none in 2015; none in 2014).

Management considers various factors when making funding decisions such as regulatory requirements, actuarially determined minimum contribution requirements and contributions required to avoid benefit restrictions for the pension plans. Contributions are based on estimates and assumptions which are subject to change. We expect no additional contributions to the defined benefit pension plans in 2017 beyond the $15.2 million contributed in January 2017. We expect no contributions to the defined benefit postretirement health and life plans in 2017.

Accounting for defined benefit pension and other postretirement benefit plans requires that employers recognize on a prospective basis the funded status of their defined benefit pension and other postretirement plans on their balance sheet and recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost.

The defined benefit pension and postretirement health and life benefit expense (credit) recognized annually by our regulated utilities are expected to be recovered (refunded) through rates filed with our regulatory jurisdictions. As a result, these amounts that are required to otherwise be recognized in accumulated other comprehensive income have been recognized as a long-term regulatory asset (regulatory liability) on the Consolidated Balance Sheet, in accordance with the accounting standards for the effect of certain types of regulation applicable to our Regulated Operations. The defined benefit pension and postretirement health and life benefit expense (credits) associated with our other operations are recognized in accumulated other comprehensive income.



Pension Obligation and Funded Status
As of December 31	2016			2015
Millions
Accumulated Benefit Obligation		$698.8			$665.0
Change in Benefit Obligation
Obligation, Beginning of Year		$709.8			$714.5
Service Cost	8.1			10.1
Interest Cost	33.2			29.9
Actuarial (Gain) Loss	12.4			(31.2		)
Benefits Paid	(44.5		)	(40.2		)
Participant Contributions	24.3			26.7
Obligation, End of Year		$743.3			$709.8
Change in Plan Assets
Fair Value, Beginning of Year		$521.3			$544.2
Actual Return on Plan Assets	48.8			(10.8		)
Employer Contribution (a)	31.9			28.1
Benefits Paid	(44.5		)	(40.2		)
Fair Value, End of Year		$557.5			$521.3
Funded Status, End of Year	$(185.8)			$(188.5)

Net Pension Amounts Recognized in Consolidated Balance Sheet Consist of:
Current Liabilities	$(1.4)			$(1.3)
Non-Current Liabilities	$(184.4)			$(187.2)


(a)	Includes Participant Contributions noted above.

NOTE 15. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS (Continued)

The pension costs that are reported as a component within the Consolidated Balance Sheet, reflected in long-term regulatory assets or liabilities and accumulated other comprehensive income, consist of a net loss of $250.4 million as of December 31, 2016 (net loss of $252.7 million as of December 31, 2015).



Components of Net Periodic Pension Expense
Year Ended December 31	2016			2015			2014
Millions
Service Cost		$8.1			$10.1			$8.3
Interest Cost	33.2			29.9			29.8
Expected Return on Plan Assets	(43.6		)	(40.7		)	(38.2		)
Amortization of Loss	9.5			17.9			14.2
Amortization of Prior Service Cost	—			0.2			0.3
Net Pension Expense		$7.2			$17.4			$14.4



Other Changes in Pension Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income and Regulatory Assets or Liabilities
Year Ended December 31	2016		2015
Millions
Net Loss	$7.2			$20.2
Amortization of Prior Service Cost	—		(0.2		)
Amortization of Loss	(9.5	)	(17.9		)
Total Recognized in Other Comprehensive Income and Regulatory Assets or Liabilities	$(2.3)			$2.1



Information for Pension Plans with an Accumulated Benefit Obligation in Excess of Plan Assets
As of December 31	2016		2015
Millions
Projected Benefit Obligation		$743.3		$709.8
Accumulated Benefit Obligation		$698.8		$665.0
Fair Value of Plan Assets		$557.5		$521.3

NOTE 15. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS (Continued)



Postretirement Health and Life Obligation and Funded Status
As of December 31	2016			2015
Millions
Change in Benefit Obligation
Obligation, Beginning of Year		$160.2			$170.9
Service Cost	3.9			4.3
Interest Cost	7.4			7.2
Actuarial (Gain) Loss	11.9			(14.4		)
Benefits Paid	(13.1		)	(10.7		)
Participant Contributions	3.1			2.9
Obligation, End of Year		$173.4			$160.2
Change in Plan Assets
Fair Value, Beginning of Year		$153.4			$163.2
Actual Return on Plan Assets	9.6			(3.5		)
Employer Contribution	1.3			1.5
Participant Contributions	3.1			2.9
Benefits Paid	(13.1		)	(10.7		)
Fair Value, End of Year		$154.3			$153.4
Funded Status, End of Year	$(19.1)			$(6.8)

Net Postretirement Health and Life Amounts Recognized in Consolidated Balance Sheet Consist of:
Non-Current Assets	$1.4			$6.4
Current Liabilities	$(1.1)			$(1.0)
Non-Current Liabilities	$(19.4)			$(12.2)

According to the accounting standards for retirement benefits, only assets in the VEBAs are treated as plan assets in the above table for the purpose of determining funded status. In addition to the postretirement health and life assets reported in the previous table, we had $17.6 million in irrevocable grantor trusts included in Other Investments on the Consolidated Balance Sheet as of December 31, 2016 ($17.4 million as of December 31, 2015).

The postretirement health and life costs that are reported as a component within the Consolidated Balance Sheet, reflected in regulatory long-term assets or liabilities and accumulated other comprehensive income, consist of the following:



Unrecognized Postretirement Health and Life Costs
As of December 31	2016		2015
Millions
Net Loss	$19.8		$6.5
Prior Service Credit	(4.7	)	(7.6	)
Total Unrecognized Postretirement Health and Life Cost (Credit)	$15.1		$(1.1)



Components of Net Periodic Postretirement Health and Life Expense
Year Ended December 31	2016			2015			2014
Millions
Service Cost		$3.9			$4.3			$3.4
Interest Cost	7.4			7.2			7.3
Expected Return on Plan Assets	(11.2		)	(10.9		)	(10.3		)
Amortization of Loss	0.2			0.4			0.5
Amortization of Prior Service Credit	(2.9		)	(3.0		)	(2.5		)
Net Postretirement Health and Life Credit	$(2.6)			$(2.0)			$(1.6)

NOTE 15. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS (Continued)



Other Changes in Postretirement Benefit Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income and Regulatory Assets or Liabilities
Year Ended December 31	2016			2015
Millions
Net Loss		$13.5		—
Amortization of Prior Service Credit	2.9				$3.0
Amortization of Loss	(0.2		)	(0.4		)
Total Recognized in Other Comprehensive Income and Regulatory Assets or Liabilities	$16.2			$2.6



Estimated Future Benefit Payments	Pension		Postretirement Health and Life
Millions
2017		$45.0		$9.3
2018		$45.2		$9.4
2019		$45.4		$9.7
2020		$45.5		$9.9
2021		$45.8		$10.0
Years 2022 – 2026		$231.0		$51.4

The pension and postretirement health and life costs recorded in regulatory long-term assets or liabilities and accumulated other comprehensive income expected to be recognized as a component of net pension and postretirement benefit costs for the year ending December 31, 2017, are as follows:



	Pension	Postretirement Health and Life
Millions
Net Loss	$9.9	$0.3
Prior Service Credit	—	(2.0)
Total Pension and Postretirement Health and Life Cost (Credit)	$9.9	$(1.7)



Assumptions Used to Determine Benefit Obligation
As of December 31	2016	2015
Discount Rate
Pension	4.53%	4.72%
Postretirement Health and Life	4.57%	4.73%
Rate of Compensation Increase	3.70 - 4.30%	3.70 - 4.30%
Health Care Trend Rates
Trend Rate	5.00 - 7.00%	6.50%
Ultimate Trend Rate	4.50%	5.00%
Year Ultimate Trend Rate Effective	2038	2022

NOTE 15. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS (Continued)



Assumptions Used to Determine Net Periodic Benefit Costs
Year Ended December 31	2016	2015	2014
Discount Rate	4.72 - 4.73%	4.30 - 4.33%	4.93 - 4.96%
Expected Long-Term Return on Plan Assets (a)
Pension	8.00%	8.00%	8.00%
Postretirement Health and Life	6.40 - 8.00%	6.40 - 8.00%	6.40 - 8.00%
Rate of Compensation Increase	3.70 - 4.30%	3.70 - 4.30%	3.70 - 4.30%


(a)	The expected long-term rates of return used to determine net periodic benefit expense for 2017 have been reduced to 7.50 percent for pension expense and 6.00 percent to 7.50 percent for postretirement health and life expense.

In establishing the expected long-term rate of return on plan assets, we determine the long-term historical performance of each asset class, adjust these for current economic conditions, and utilizing the target allocation of our plan assets, forecast the expected long-term rate of return.

The discount rate is computed using a bond matching study which utilizes a portfolio of high quality bonds that produce cash flows similar to the projected costs of our pension and other postretirement plans.

The Company utilizes actuarial assumptions about mortality to calculate the pension and postretirement health and life benefit obligations. In 2014, revised mortality tables were released, and the Company adopted updated mortality tables as of December 31, 2014.



Sensitivity of a One Percent Change in Health Care Trend Rates
	One Percent Increase		One Percent Decrease
Millions
Effect on Total of Postretirement Health and Life Service and Interest Cost		$20.1	$(16.7)
Effect on Postretirement Health and Life Obligation		$1.8	$(1.4)



Actual Plan Asset Allocations	Pension				Postretirement Health and Life (a)
	2016		2015		2016		2015
Equity Securities	49	%	47	%	60	%	57	%
Debt Securities	39	%	39	%	34	%	35	%
Private Equity	7	%	8	%	6	%	8	%
Real Estate	5	%	6	%	—		—
	100	%	100	%	100	%	100	%


(a)	Includes VEBAs and irrevocable grantor trusts.

There were no shares of ALLETE common stock included in pension plan equity securities as of December 31, 2016 (no shares as of December 31, 2015). On January 17, 2017, we contributed approximately 0.2 million shares of ALLETE common stock to our pension plan, which had an aggregate value of $13.5 million when contributed.

In 2013, the defined benefit pension plan adopted a dynamic asset allocation strategy (glide path) that increases the invested allocation to fixed income assets as the funding level of the plan increases to better match the sensitivity of the plan’s assets and liabilities to changes in interest rates. This is expected to reduce the volatility of reported pension plan expenses. The postretirement health and life plans’ assets continue to be diversified to achieve strong returns within managed risk. Equity securities are diversified among domestic companies with large, mid and small market capitalizations, as well as investments in international companies. The majority of debt securities are made up of investment grade bonds.

NOTE 15. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS (Continued)

Following are the current targeted allocations as of December 31, 2016:



Plan Asset Target Allocations	Pension		Postretirement Health and Life (a)
Equity Securities	56	%	60	%
Debt Securities	35	%	37	%
Real Estate	9	%	3	%
	100	%	100	%


(a)	Includes VEBAs and irrevocable grantor trusts.

Fair Value

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). We utilize market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. We primarily apply the market approach for recurring fair value measurements and endeavor to utilize the best available information. Accordingly, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. These inputs, which are used to measure fair value, are prioritized through the fair value hierarchy. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy are as follows:

Level 1 — Quoted prices are available in active markets for identical assets or liabilities as of the reported date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. This category includes various U.S. equity securities, public mutual funds, and futures. These instruments are valued using the closing price from the applicable exchange or whose value is quoted and readily traded daily.

Level 2 — Pricing inputs are other than quoted prices in active markets, but are either directly or indirectly observable as of the reported date. The types of assets and liabilities included in Level 2 are typically either comparable to actively traded securities or contracts, such as treasury securities with pricing interpolated from recent trades of similar securities, or priced with models using highly observable inputs. This category includes various bonds and non-public funds whose underlying investments may be Level 1 or Level 2 securities.

Level 3 — Significant inputs that are generally less observable from objective sources. The types of assets and liabilities included in Level 3 are those with inputs requiring significant management judgment or estimation, such as the complex and subjective models and forecasts used to determine the fair value. This category includes private equity funds and real estate valued through external appraisal processes. Valuation methodologies incorporate pricing models, discounted cash flow models, and similar techniques which utilize capitalization rates, discount rates, cash flows and other factors.

NOTE 15. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS (Continued)

Fair Value (Continued)

Pension Fair Value



	Fair Value as of December 31, 2016
Recurring Fair Value Measures	Level 1		Level 2		Level 3		Total
Millions
Assets:
Equity Securities:
U.S. Large-cap (a)		$94.6	—		—			$94.6
U.S. Mid-cap Growth (a)	—			$44.8	—		44.8
U.S. Small-cap (a)	—		45.0		—		45.0
International	46.7		42.3		—		89.0
Debt Securities:
Fixed Income	—		200.1		—		200.1
Cash and Cash Equivalents	17.8		—		—		17.8
Private Equity Funds	—		—			$40.6	40.6
Real Estate	—		—		25.6		25.6
Total Fair Value of Assets		$159.1		$332.2		$66.2		$557.5

(a)

The underlying investments classified under U.S. Equity Securities consist of money market funds (Level 1), mutual funds (Level 1) and actively-managed funds (Level 2), which are combined with futures, and settle daily, to achieve the returns of the U.S. Equity Securities Mid-cap Growth and Small-cap funds. Our exposure with respect to these investments includes both the futures and the underlying investments.



Recurring Fair Value Measures
Activity in Level 3	Private Equity Funds			Real Estate
Millions
Balance as of December 31, 2015		$43.3			$28.9
Actual Return on Plan Assets	5.0			2.3
Purchases, Sales, and Settlements – Net	(7.7		)	(5.6		)
Balance as of December 31, 2016		$40.6			$25.6

NOTE 15. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS (Continued)

Pension Fair Value (Continued)



	Fair Value as of December 31, 2015
Recurring Fair Value Measures	Level 1		Level 2		Level 3		Total
Millions
Assets:
Equity Securities:
U.S. Large-cap (a)		$33.9		$42.1	—			$76.0
U.S. Mid-cap Growth (a)	14.2		17.7		—		31.9
U.S. Small-cap (a)	14.5		17.9		—		32.4
Mutual Funds	8.4		—		—		8.4
International	44.7		42.0		—		86.7
Debt Securities:
Mutual Funds	0.1		—		—		0.1
Fixed Income	2.7		185.3		—		188.0
Cash and Cash Equivalents	25.6		—		—		25.6
Private Equity Funds	—		—			$43.3	43.3
Real Estate	—		—		28.9		28.9
Total Fair Value of Assets		$144.1		$305.0		$72.2		$521.3

(a)

The underlying investments classified under U.S. Equity Securities consist of money market funds (Level 1) and actively-managed funds (Level 2), which are combined with futures, and settle daily, to achieve the returns of the U.S. Equity Securities Large-cap, Mid-cap Growth, and Small-cap funds. Our exposure with respect to these investments includes both the futures and the underlying investments.



Recurring Fair Value Measures
Activity in Level 3	Private Equity Funds			Real Estate
Millions
Balance as of December 31, 2014		$43.3			$28.9
Actual Return on Plan Assets	2.6			2.9
Purchases, Sales, and Settlements – Net	(2.6		)	(2.9		)
Balance as of December 31, 2015		$43.3			$28.9

NOTE 15. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS (Continued)

Postretirement Health and Life Fair Value



	Fair Value as of December 31, 2016
Recurring Fair Value Measures	Level 1		Level 2		Level 3		Total
Millions
Assets:
Equity Securities:
U.S. Large-cap (a)		$27.9	—		—			$27.9
U.S. Mid-cap Growth (a)	20.7		—		—		20.7
U.S. Small-cap (a)	14.0		—		—		14.0
International	27.9		—		—		27.9
Debt Securities:
Mutual Funds	48.6		—		—		48.6
Fixed Income	—			$4.6	—		4.6
Cash and Cash Equivalents	1.1		—		—		1.1
Private Equity Funds	—		—			$9.5	9.5
Total Fair Value of Assets		$140.2		$4.6		$9.5		$154.3


(a)	The underlying investments classified under U.S. Equity Securities consist of mutual funds (Level 1).



Recurring Fair Value Measures
Activity in Level 3	Private Equity Funds
Millions
Balance as of December 31, 2015		$12.0
Actual Return on Plan Assets	1.4
Purchases, Sales, and Settlements – Net	(3.9		)
Balance as of December 31, 2016		$9.5



	Fair Value as of December 31, 2015
Recurring Fair Value Measures	Level 1		Level 2		Level 3		Total
Millions
Assets:
Equity Securities:
U.S. Large-cap (a)		$28.2	—		—			$28.2
U.S. Mid-cap Growth (a)	19.1		—		—		19.1
U.S. Small-cap (a)	12.1		—		—		12.1
International	26.8		—		—		26.8
Debt Securities:
Mutual Funds	45.2		—		—		45.2
Fixed Income	—			$8.4	—		8.4
Cash and Cash Equivalents	1.6		—		—		1.6
Private Equity Funds	—		—			$12.0	12.0
Total Fair Value of Assets		$133.0		$8.4		$12.0		$153.4


(a)	The underlying investments classified under U.S. Equity Securities consist of mutual funds (Level 1).

NOTE 15. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS (Continued)

Postretirement Health and Life Fair Value (Continued)



Recurring Fair Value Measures
Activity in Level 3	Private Equity Funds
Millions
Balance as of December 31, 2014		$12.9
Actual Return on Plan Assets	1.2
Purchases, Sales, and Settlements – Net	(2.1		)
Balance as of December 31, 2015		$12.0

Accounting and disclosure requirements for the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (Act) provide guidance for employers that sponsor postretirement health care plans that provide prescription drug benefits. We provide a fully insured postretirement health benefit, including a prescription drug benefit, which qualifies us for a federal subsidy under the Act. The federal subsidy is reflected in the premiums charged to us by the insurance company.