Retirement Plans and Other Postretirement Benefits

Pinnacle West sponsors a qualified defined benefit and account balance pension plan (The Pinnacle West Capital Corporation Retirement Plan) and a non-qualified supplemental excess benefit retirement plan for the employees of Pinnacle West and its subsidiaries. All new employees participate in the account balance plan. Defined benefit plans specify the amount of benefits a plan participant is to receive using information about the participant. The pension plan covers nearly all employees. The supplemental excess benefit retirement plan covers officers of the Company and highly compensated employees designated for participation by the Board of Directors. Our employees do not contribute to the plans. We calculate the benefits based on age, years of service and pay.

Pinnacle West also sponsors an other postretirement benefit plan (Pinnacle West Capital Corporation Group Life and Medical Plan) for the employees of Pinnacle West and its subsidiaries. This plan provides medical and life insurance benefits to retired employees. Employees must retire to become eligible for these retirement benefits, which are based on years of service and age. For the medical insurance plan, retirees make contributions to cover a portion of the plan costs. For the life insurance plan, retirees do not make contributions. We retain the right to change or eliminate these benefits.

On September 30, 2014, Pinnacle West announced plan design changes to the other postretirement benefit plan, which required an interim remeasurement of the benefit obligation for the plan. Effective January 1, 2015, those eligible retirees and dependents over age 65 and on Medicare can choose to be enrolled in a Health Reimbursement Arrangement (HRA). The Company will provide a subsidy allowing post-65 retirees to purchase a Medicare supplement plan on a private exchange network. The remeasurement of the benefit obligation included updating the assumptions. The remeasurement reduced net periodic benefit costs in 2014 by $10 million ($5 million of which reduced expense). The remeasurement also resulted in a decrease in Pinnacle West’s other postretirement benefit obligation of $316 million, which was offset by the related regulatory asset and accumulated other comprehensive income.

Because of the plan changes, the Company is currently in the process of seeking IRS and regulatory approval to move approximately $100 million of the other postretirement benefit trust assets into a new trust account to pay for active union employee medical costs.

Pinnacle West uses a December 31 measurement date each year for its pension and other postretirement benefit plans. The market-related value of our plan assets is their fair value at the measurement date. See Note 13 for further discussion of how fair values are determined. Due to subjective and complex judgments, which may be required in determining fair values, actual results could differ from the results estimated through the application of these methods.

A significant portion of the changes in the actuarial gains and losses of our pension and postretirement plans is attributable to APS and therefore is recoverable in rates. Accordingly, these changes are recorded as a regulatory asset or regulatory liability. In its 2009 retail rate case settlement, APS received approval to defer a portion of pension and other postretirement benefit cost increases incurred in 2011 and 2012. We deferred pension and other postretirement benefit costs of approximately $14 million in 2012 and $11 million in 2011. Pursuant to an ACC regulatory order, we began amortizing the regulatory asset over three years beginning in July 2012. We amortized approximately $5 million in 2015, $8 million in 2014, $8 million in 2013 and $4 million in 2012.

The following table provides details of the plans’ net periodic benefit costs and the portion of these costs charged to expense (including administrative costs and excluding amounts capitalized as overhead construction, billed to electric plant participants or charged to the regulatory asset or liability) (dollars in thousands):



	Pension									Other Benefits
	2015			2014			2013			2015			2014			2013
Service cost-benefits earned during the period	$	59,627		$	53,080		$	64,195		$	16,827		$	18,139		$	23,597
Interest cost on benefit obligation	123,983			129,194			112,392			28,102			41,243			41,536
Expected return on plan assets	(179,231		)	(158,998		)	(146,333		)	(36,855		)	(46,400		)	(45,717		)
Amortization of:
Prior service cost (credit)	594			869			1,097			(37,968		)	(9,626		)	(179		)
Net actuarial loss	31,056			10,963			39,852			4,881			1,175			11,310
Net periodic benefit cost	$	36,029		$	35,108		$	71,203		$	(25,013	)	$	4,531		$	30,547
Portion of cost charged to expense	$	20,036		$	21,985		$	38,968		$	(10,391	)	$	6,000		$	18,469

The following table shows the plans’ changes in the benefit obligations and funded status for the years 2015 and 2014 (dollars in thousands):



	Pension						Other Benefits
	2015			2014			2015			2014
Change in Benefit Obligation
Benefit obligation at January 1	$	3,078,648		$	2,646,530		$	682,335		$	890,418
Service cost	59,627			53,080			16,827			18,139
Interest cost	123,983			129,194			28,102			41,243
Benefit payments	(137,115		)	(128,550		)	(24,988		)	(29,054		)
Actuarial (gain) loss	(91,340		)	378,394			(55,256		)	150,188
Plan amendments	—			—			—			(388,599		)
Benefit obligation at December 31	3,033,803			3,078,648			647,020			682,335
Change in Plan Assets
Fair value of plan assets at January 1	2,615,404			2,264,121			834,625			748,339
Actual return on plan assets	(44,690		)	292,992			(2,399		)	105,223
Employer contributions	100,000			175,000			791			770
Benefit payments	(127,940		)	(116,709		)	—			(19,707		)
Fair value of plan assets at December 31	2,542,774			2,615,404			833,017			834,625
Funded Status at December 31	$	(491,029	)	$	(463,244	)	$	185,997		$	152,290

The following table shows the projected benefit obligation and the accumulated benefit obligation for pension plans with an accumulated obligation in excess of plan assets as of December 31, 2015 and 2014 (dollars in thousands):



	2015		2014
Projected benefit obligation	$	3,033,803	$	3,078,648
Accumulated benefit obligation	2,873,467		2,873,741
Fair value of plan assets	2,542,774		2,615,404

The following table shows the amounts recognized on the Consolidated Balance Sheets as of December 31, 2015 and 2014 (dollars in thousands):



	Pension						Other Benefits
	2015			2014			2015		2014
Noncurrent asset	$	—		$	—		$	185,997	$	152,290
Current liability	(10,031		)	(9,508		)	—		—
Noncurrent liability	(480,998		)	(453,736		)	—		—
Net amount recognized	$	(491,029	)	$	(463,244	)	$	185,997	$	152,290

The following table shows the details related to accumulated other comprehensive loss as of December 31, 2015 and 2014 (dollars in thousands):



	Pension						Other Benefits
	2015			2014			2015			2014
Net actuarial loss	$	679,501		$	577,976		$	127,124		$	148,006
Prior service cost (credit)	609			1,203			(341,301		)	(379,269		)
APS’s portion recorded as a regulatory (asset) liability	(619,223		)	(485,037		)	213,621			230,916
Income tax expense (benefit)	(23,663		)	(36,890		)	925			851
Accumulated other comprehensive loss	$	37,224		$	57,252		$	369		$	504

The following table shows the estimated amounts that will be amortized from accumulated other comprehensive loss and regulatory assets and liabilities into net periodic benefit cost in 2016 (dollars in thousands):



	Pension		Other Benefits
Net actuarial loss	$	38,923	$	3,784
Prior service cost (credit)	527		(37,884		)
Total amounts estimated to be amortized from accumulated other comprehensive loss (gain) and regulatory assets (liabilities) in 2016	$	39,450	$	(34,100	)

The following table shows the weighted-average assumptions used for both the pension and other benefits to determine benefit obligations and net periodic benefit costs:



	Benefit Obligations As of December 31,				Benefit Costs For the Years Ended December 31,
	2015		2014		2015		2014				2013
							January - September		October - December
Discount rate – pension	4.37	%	4.02	%	4.02	%	4.88	%	4.88	%	4.01	%
Discount rate – other benefits	4.52	%	4.14	%	4.14	%	5.10	%	4.41	%	4.20	%
Rate of compensation increase	4.00	%	4.00	%	4.00	%	4.00	%	4.00	%	4.00	%
Expected long-term return on plan assets - pension	N/A		N/A		6.90	%	6.90	%	6.90	%	7.00	%
Expected long-term return on plan assets - other benefits	N/A		N/A		4.45	%	6.80	%	4.25	%	7.00	%
Initial healthcare cost trend rate (pre-65 participants)	7.00	%	7.00	%	7.00	%	7.50	%	7.50	%	7.50	%
Initial healthcare cost trend rate (post-65 participants)	5.00	%	5.00	%	5.00	%	7.50	%	5.00	%	7.50	%
Ultimate healthcare cost trend rate	5.00	%	5.00	%	5.00	%	5.00	%	5.00	%	5.00	%
Number of years to ultimate trend rate (pre-65 participants)	4		4		4		4		4		4
Number of years to ultimate trend rate (post-65 participants)	0		0		0		4		0		4

In selecting the pretax expected long-term rate of return on plan assets, we consider past performance and economic forecasts for the types of investments held by the plan. For 2016, we are assuming a 6.90% long-term rate of return for pension assets and 4.74% (before tax) for other benefit assets, which we believe is reasonable given our asset allocation in relation to historical and expected performance.

In October 2014, the Society of Actuaries’ Retirement Plans Experience Committee issued its final reports on its recommended mortality basis (“RP-2014 Mortality Tables Report” and "Mortality Improvement Scale MP-2014 Report"). At December 31, 2014, we updated our mortality assumptions using the recommended basis with modifications to better reflect our plan experience and additional data regarding mortality trends. The updated mortality assumptions resulted in a $67 million increase in Pinnacle West’s pension and other postretirement obligations, which was offset by the related regulatory asset, regulatory liability and accumulated other comprehensive income.

In selecting our healthcare trend rates, we consider past performance and forecasts of healthcare costs. A one percentage point change in the assumed initial and ultimate healthcare cost trend rates would have the following effects (dollars in thousands):



	1% Increase		1% Decrease
Effect on other postretirement benefits expense, after consideration of amounts capitalized or billed to electric plant participants	$	8,834	$	(5,890	)
Effect on service and interest cost components of net periodic other postretirement benefit costs	9,069		(6,949		)
Effect on the accumulated other postretirement benefit obligation	100,322		(80,332		)

Plan Assets

The Board of Directors has delegated oversight of the pension and other postretirement benefit plans’ assets to an Investment Management Committee (“Committee”). The Committee has adopted investment policy statements (“IPS”) for the pension and the other postretirement benefit plans’ assets. The investment strategies for these plans include external management of plan assets, and prohibition of investments in Pinnacle West securities.

The overall strategy of the pension plan’s IPS is to achieve an adequate level of trust assets relative to the benefit obligations. To achieve this objective, the plan’s investment policy provides for mixes of investments including long-term fixed income assets and return-generating assets. The target allocation between return-generating and long-term fixed income assets is defined in the IPS and is a function of the plan’s funded status. The plan’s funded status is reviewed on at least a monthly basis.

Long-term fixed income assets, also known as liability-hedging assets, are designed to offset changes in the benefit obligations due to changes in interest rates. Long-term fixed income assets consist primarily of fixed income debt securities issued by the U.S. Treasury, other government agencies, and corporations. Long-term fixed income assets may also include interest rate swaps, U.S. Treasury futures and other instruments.

Return-generating assets are intended to provide a reasonable long-term rate of investment return with a prudent level of volatility. Return-generating assets are composed of U.S. equities, international equities, and alternative investments. International equities include investments in both developed and emerging markets. Alternative investments include investments in real estate, private equity and various other strategies. The plan may hold investments in return-generating assets by holding securities in partnerships and common and collective trusts.

Based on the IPS, and given the pension plan’s funded status at year-end 2015, the long-term fixed income assets had a target allocation of 58% with a permissible range of 55% to 61% and the return-generating assets had a target allocation of 42% with a permissible range of 39% to 45%. The return-generating assets have additional target allocations, as a percent of total plan assets, of 22% equities in U.S. and other developed markets, 6% equities in emerging markets, and 14% in alternative investments. The pension plan IPS does not provide for a specific mix of long-term fixed income assets, but does expect the average credit quality of such assets to be investment grade. As of December 31, 2015, long-term fixed income assets represented 60% of total pension plan assets, and return-generating assets represented 40% of total pension plan assets.

As of December 31, 2015, the asset allocation for other postretirement benefit plan assets is governed by the IPS for those plans, which provides for different asset allocation target mixes depending on the characteristics of the liability. Some of these asset allocation target mixes vary with the plan’s funded status. As of December 31, 2015, investment in fixed income assets represented 40% of the other postretirement benefit plan total assets, and non-fixed income assets represented 60% of the other postretirement benefit plan’s assets. Fixed income assets are primarily invested in corporate bonds of investment-grade U.S. issuers, and U.S. Treasuries. Non-fixed income assets are primarily invested in large cap U.S. equities in diverse industries, and international equities in both emerging and developed markets.

See Note 13 for a discussion on the fair value hierarchy and how fair value methodologies are applied. The plans invest directly in fixed income and equity securities, in addition to investing indirectly in fixed income securities, equity securities and real estate through the use of mutual funds, partnerships and common and collective trusts. Equity securities held directly by the plans are valued using quoted active market prices from the published exchange on which the equity security trades, and are classified as Level 1. Fixed income securities issued by the U.S. Treasury held directly by the plans are valued using quoted active market prices, and are classified as Level 1. Fixed income securities issued by corporations, municipalities, and other agencies are primarily valued using quoted inactive market prices, or quoted active market prices for similar securities, or by utilizing calculations which incorporate observable inputs such as yield, maturity and credit quality. These instruments are classified as Level 2.

Mutual funds, partnerships, and common and collective trusts are valued utilizing a net asset value (NAV) concept or its equivalent. Exchange traded mutual funds, are classified as Level 1, as the valuation for these instruments is based on the active market in which the fund trades.

Common and collective trusts, are maintained by banks or investment companies and hold certain investments in accordance with a stated set of objectives (such as tracking the performance of the S&P 500 Index). The trust's shares are offered to a limited group of investors, and are not traded in an active market. The NAV for trusts investing in exchange traded equities is derived from the quoted active market prices of the underlying securities held by the trusts. The NAV for trusts investing in real estate is derived from the appraised values of the trust's underlying real estate assets. As of December 31, 2015, the plans were able to transact in the common and collective trusts at NAV and classifies these investments as Level 2.

Investments in partnerships are also valued using the concept of NAV, which is derived from the value of the partnerships' underlying assets. The plan's partnerships holdings relate to investments in high-yield fixed income instruments and assets of privately held portfolio companies. Certain partnerships also include funding commitments that may require the plan to contribute up to $75 million to these partnerships; as of December 31, 2015, approximately $40 million of these commitments have been funded. Partnerships are classified as Level 2 if the plan is able to transact in the partnership at the NAV, otherwise the partnership is classified as Level 3.

The plans’ trustee provides valuation of our plan assets by using pricing services that utilize methodologies described to determine fair market value. We have internal control procedures to ensure this information is consistent with fair value accounting guidance. These procedures include assessing valuations using an independent pricing source, verifying that pricing can be supported by actual recent market transactions, assessing hierarchy classifications, comparing investment returns with benchmarks, and obtaining and reviewing independent audit reports on the trustee’s internal operating controls and valuation processes.

The fair value of Pinnacle West’s pension plan and other postretirement benefit plan assets at December 31, 2015, by asset category, are as follows (dollars in thousands):



	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Other (b)		Balance at December 31, 2015
Pension Plan:
Assets:
Cash and cash equivalents	$	1,893	$	—	$	—	$	—	$	1,893
Fixed income securities:
Corporate	—		1,108,736		—		—		1,108,736
U.S. Treasury	274,778		—		—		—		274,778
Other (a)	—		113,008		—		—		113,008
Equities:
U.S. companies	233,021		—		—		—		233,021
International companies	14,680		—		—		—		14,680
Common and collective trusts:
U.S. equities	—		130,097		—		—		130,097
International equities	—		185,892		—		—		185,892
Real estate	—		150,359		—		—		150,359
Partnerships	—		127,840		42,097		—		169,937
Mutual funds - International equities	116,307		—		—		—		116,307
Short-term investments and other	—		29,599		—		14,467		44,066
Total Pension Plan	$	640,679	$	1,845,531	$	42,097	$	14,467	$	2,542,774
Other Benefits:
Assets:
Cash and cash equivalents	$	240	$	—	$	—	$	—	$	240
Fixed income securities:
Corporate	—		217,026		—		—		217,026
U.S. Treasury	131,435		—		—		—		131,435
Other (a)	—		31,106		—		—		31,106
Equities:
U.S. companies	253,193		—		—		—		253,193
International companies	12,390		—		—		—		12,390
Common and collective trusts:
U.S. equities	—		81,516		—		—		81,516
International equities	—		28,539		—		—		28,539
Real estate	—		13,512		—		—		13,512
Mutual funds - International equities	52,568		—		—		—		52,568
Short-term investments and other	5,065		3,331		—		3,096		11,492
Total Other Benefits	$	454,891	$	375,030	$	—	$	3,096	$	833,017


(a)	This category consists primarily of debt securities issued by municipalities.


(b)	Represents plan receivables and payables.

The fair value of Pinnacle West’s pension plan and other postretirement benefit plan assets at December 31, 2014, by asset category, are as follows (dollars in thousands):



	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Other (b)		Balance at December 31, 2014
Pension Plan:
Assets:
Cash and cash equivalents	$	387	$	—	$	—	$	—	$	387
Fixed Income Securities:
Corporate	—		1,162,096		—		—		1,162,096
U.S. Treasury	291,817		—		—		—		291,817
Other (a)	—		113,265		—		—		113,265
Equities:
U.S. Companies	246,387		—		—		—		246,387
International Companies	18,069		—		—		—		18,069
Common and collective trusts:
U.S. Equities	—		127,336		—		—		127,336
International Equities	—		317,167		—		—		317,167
Real estate	—		129,715		—		—		129,715
Partnerships	—		138,337		27,929		—		166,266
Short-term investments and other	—		26,016		—		16,883		42,899
Total Pension Plan	$	556,660	$	2,013,932	$	27,929	$	16,883	$	2,615,404
Other Benefits:
Assets:
Cash and cash equivalents	$	318	$	—	$	—	$	—	$	318
Fixed Income Securities:
Corporate	—		187,961		—		—		187,961
U.S. Treasury	130,967		—		—		—		130,967
Other (a)	—		35,291		—		—		35,291
Equities:
U.S. Companies	265,106		—		—		—		265,106
International Companies	17,813		—		—		—		17,813
Common and collective trusts:
U.S. Equities	—		88,258		—		—		88,258
International Equities	—		85,746		—		—		85,746
Real Estate	—		11,657		—		—		11,657
Short-term investments and other	—		7,408		—		4,100		11,508
Total Other Benefits	$	414,204	$	416,321	$	—	$	4,100	$	834,625


(a)	This category consists primarily of debt securities issued by municipalities.


(b)	Represents plan receivables and payables.

The following table shows the changes in fair value for assets that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2015 and 2014 (dollars in thousands):



	Pension
Partnerships	2015			2014
Beginning balance at January 1	$	27,929		$	8,660
Actual return on assets still held at December 31	2,789			927
Purchases	13,187			19,984
Sales	(1,808		)	(1,642		)
Transfers in and/or out of Level 3	—			—
Ending balance at December 31	$	42,097		$	27,929

Contributions

Future year contribution amounts are dependent on plan asset performance and plan actuarial assumptions. We made contributions to our pension plan totaling $100 million in 2015, $175 million in 2014, and $141 million in 2013. The minimum required contributions for the pension plan are zero for the next three years. We expect to make voluntary contributions up to a total of $300 million during the 2016-2018 period. With regard to contributions to our other postretirement benefit plans, we made a contribution of $1 million in 2015, $1 million in 2014, and $14 million in 2013. We expect to make contributions of approximately $1 million in each of the next three years to our other postretirement benefit plans. APS funds its share of the contributions. APS’s share of the pension plan contribution was $100 million in 2015, $175 million in 2014, and $140 million in 2013. APS’s share of the contributions to the other postretirement benefit plan was $1 million in 2015, $1 million in 2014, and $14 million in 2013.

Estimated Future Benefit Payments

Benefit payments, which reflect estimated future employee service, for the next five years and the succeeding five years thereafter, are estimated to be as follows (dollars in thousands):



Year	Pension		Other Benefits
2016	$	152,146	$	26,468
2017	171,005		28,444
2018	170,534		30,490
2019	180,700		32,438
2020	188,988		33,982
Years 2021-2025	1,023,451		184,335

Electric plant participants contribute to the above amounts in accordance with their respective participation agreements.

Employee Savings Plan Benefits

Pinnacle West sponsors a defined contribution savings plan for eligible employees of Pinnacle West and its subsidiaries. In 2015, costs related to APS’s employees represented 99% of the total cost of this plan. In a defined contribution savings plan, the benefits a participant receives result from regular contributions participants make to their own individual account, the Company’s matching contributions and earnings or losses on their investments. Under this plan, the Company matches a percentage of the participants’ contributions in cash which is then invested in the same investment mix as participants elect to invest their own future contributions. Pinnacle West recorded expenses for this plan of approximately $9 million for 2015, $9 million for 2014, and $9 million for 2013.