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 other postretirement benefit plans (Pinnacle West Capital Corporation Group Life and Medical Plan and Pinnacle West Capital Corporation Post-65 Retiree Health Reimbursement Arrangement) for the employees of Pinnacle West and its subsidiaries. These plans provide 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 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 is providing 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 2014 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 plan changes in September 2014, the Company is currently in the process of seeking IRS approval to move approximately $186 million of other postretirement benefit trust assets into a new trust account to pay for active union employee medical costs. In December 2016, FERC approved a methodology for determining the amount of other postretirement benefit trust assets to transfer into a new trust account to pay for active union employee medical costs. On January 2, 2018, these funds were moved to the new trust account. The Company negotiated a draft Closing Agreement granting tentative approval from the IRS prior to the transfer. Subsequent to the transfer, the Company submitted proof of the transfer to the IRS and expects to execute a final Closing Agreement early in 2018. Per the terms of an order from FERC, the Company must also make an informational filing with FERC. The Company made this FERC filing during February 2018. It is the Company’s understanding that completion of these regulatory requirements will then permit access to the approximately $186 million for the sole purpose of paying active union employee medical benefits.

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
	2017			2016			2015			2017			2016			2015
Service cost-benefits earned during the period	$	54,858		$	53,792		$	59,627		$	17,119		$	14,993		$	16,827
Interest cost on benefit obligation	129,756			131,647			123,983			29,959			29,721			28,102
Expected return on plan assets	(174,271		)	(173,906		)	(179,231		)	(53,401		)	(36,495		)	(36,855		)
Amortization of:
Prior service cost (credit)	81			527			594			(37,842		)	(37,883		)	(37,968		)
Net actuarial loss	47,900			40,717			31,056			5,118			4,589			4,881
Net periodic benefit cost	$	58,324		$	52,777		$	36,029		$	(39,047	)	$	(25,075	)	$	(25,013	)
Portion of cost charged to expense	$	27,295		$	26,172		$	20,036		$	(18,274	)	$	(12,435	)	$	(10,391	)

See Note 2 for additional information regarding accounting changes relating to ASU 2017-07, Compensation-Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.

The following table shows the plans’ changes in the benefit obligations and funded status for the years 2017 and 2016 (dollars in thousands):



	Pension						Other Benefits
	2017			2016			2017			2016
Change in Benefit Obligation
Benefit obligation at January 1	$	3,204,462		$	3,033,803		$	716,445		$	647,020
Service cost	54,858			53,792			17,119			14,993
Interest cost	129,756			131,647			29,959			29,721
Benefit payments	(166,342		)	(142,247		)	(30,144		)	(26,231		)
Actuarial loss	171,452			127,467			20,014			50,942
Benefit obligation at December 31	3,394,186			3,204,462			753,393			716,445
Change in Plan Assets
Fair value of plan assets at January 1	2,675,357			2,542,774			882,651			833,017
Actual return on plan assets	428,374			166,408			139,367			63,463
Employer contributions	100,000			100,000			353			819
Benefit payments	(146,704		)	(133,825		)	—			(14,648		)
Fair value of plan assets at December 31	3,057,027			2,675,357			1,022,371			882,651
Funded Status at December 31	$	(337,159	)	$	(529,105	)	$	268,978		$	166,206

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, 2017 and 2016 (dollars in thousands):



	2017		2016
Projected benefit obligation	$	3,394,186	$	3,204,462
Accumulated benefit obligation	3,227,233		3,049,406
Fair value of plan assets	3,057,027		2,675,357

The following table shows the amounts recognized on the Consolidated Balance Sheets as of December 31, 2017 and 2016 (dollars in thousands):



	Pension						Other Benefits
	2017			2016			2017		2016
Noncurrent asset	$	—		$	—		$	268,978	$	166,206
Current liability	(9,859		)	(19,795		)	—		—
Noncurrent liability	(327,300		)	(509,310		)	—		—
Net amount recognized	$	(337,159	)	$	(529,105	)	$	268,978	$	166,206

The following table shows the details related to accumulated other comprehensive loss as of December 31, 2017 and 2016 (dollars in thousands):



	Pension						Other Benefits
	2017			2016			2017			2016
Net actuarial loss	$	643,199		$	773,750		$	75,439		$	146,509
Prior service cost (credit)	—			81			(265,575		)	(303,417		)
APS’s portion recorded as a regulatory (asset) liability	(576,188		)	(711,059		)	189,627			156,575
Income tax expense (benefit)	(24,915		)	(24,202		)	853			833
Accumulated other comprehensive loss	$	42,096		$	38,570		$	344		$	500

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 2018 (dollars in thousands):



	Pension		Other Benefits
Net actuarial loss	$	28,334	$	—
Prior service credit	—		(37,842		)
Total amounts estimated to be amortized from accumulated other comprehensive loss (gain) and regulatory assets (liabilities) in 2018	$	28,334	$	(37,842	)

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,
	2017		2016		2017		2016		2015
Discount rate – pension	3.65	%	4.08	%	4.08	%	4.37	%	4.02	%
Discount rate – other benefits	3.71	%	4.17	%	4.17	%	4.52	%	4.14	%
Rate of compensation increase	4.00	%	4.00	%	4.00	%	4.00	%	4.00	%
Expected long-term return on plan assets - pension	N/A		N/A		6.55	%	6.90	%	6.90	%
Expected long-term return on plan assets - other benefits	N/A		N/A		6.05	%	4.45	%	4.45	%
Initial healthcare cost trend rate (pre-65 participants)	7.00	%	7.00	%	7.00	%	7.00	%	7.00	%
Initial healthcare cost trend rate (post-65 participants)	4.75	%	5.00	%	5.00	%	5.00	%	5.00	%
Ultimate healthcare cost trend rate	4.75	%	5.00	%	5.00	%	5.00	%	5.00	%
Number of years to ultimate trend rate (pre-65 participants)	8		4		4		4		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 2018, we are assuming a 6.05% long-term rate of return for pension assets and 5.55% (before tax) for other benefit assets, which we believe is reasonable given our asset allocation in relation to historical and expected performance.

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 on our December 31, 2017 amounts (dollars in thousands):



	1% Increase		1% Decrease
Effect on other postretirement benefits expense, after consideration of amounts capitalized or billed to electric plant participants	$	8,424	$	(5,616	)
Effect on service and interest cost components of net periodic other postretirement benefit costs	9,145		(7,037		)
Effect on the accumulated other postretirement benefit obligation	128,203		(98,143		)

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.

Changes in the value of long-term fixed income assets, also known as liability-hedging assets, are intended 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 and other government agencies, U.S. Treasury Futures Contracts, and fixed income debt securities issued by corporations. Long-term fixed income assets may also include interest rate swaps, 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 also hold investments in return-generating assets by holding securities in partnerships, common and collective trusts and mutual funds.

Based on the IPS, and given the pension plan's funded status at year-end 2017, the target and actual allocation for the pension plan at December 31, 2017 are as follows:



	Pension
	Target Allocation		Actual Allocation
Long-term fixed income assets	62	%	58	%
Return-generating assets	38	%	42	%
Total	100	%	100	%

The permissible range is within +/- 3% of the target allocation shown in the above table, and also considers the Plan's funded status.

The following table presents the additional target allocations, as a percent of total pension plan assets, for the return-generating assets:



Asset Class	Target Allocation
Equities in US and other developed markets	18	%
Equities in emerging markets	6	%
Alternative investments	14	%
Total	38	%

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, 2017, 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. The following table presents the actual allocations of the investment for the other postretirement benefit plan at December 31, 2017:



	Other Benefits
	Actual Allocation
Long-term fixed income assets	67	%
Return-generating assets	33	%
Total	100	%

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, U.S. Treasury Futures Contracts, 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. U.S. Treasury Future Contracts are valued using the quoted active market prices from the exchange on which they trade, 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. Mutual funds, which includes exchange traded funds (ETFs), are classified as Level 1 and valued using a NAV that is observable and 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. Investments in common and collective trusts are valued using NAV as a practical expedient and, accordingly, are not classified in the fair value hierarchy. The NAV for trusts investing in exchange traded equities, and fixed income securities is derived from the 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, 2017, the plans were able to transact in the common and collective trusts at NAV.

Investments in partnerships are also valued using the concept of NAV as a practical expedient and, accordingly, are not classified in the fair value hierarchy. The NAV for these investments 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, 2017, approximately $58 million of these commitments have been funded.

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, 2017, 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)		Other (a)		Balance at December 31, 2017
Pension Plan:
Cash and cash equivalents	$	3,830	$	—	$	—	$	3,830
Fixed income securities:
Corporate	—		1,365,194		—		1,365,194
U.S. Treasury	221,291		—		—		221,291
Other (b)	—		100,599		—		100,599
Common stock equities (c)	228,088		—		—		228,088
Mutual funds (d)	233,732		—		—		233,732
Common and collective trusts:
Equities	—		—		408,763		408,763
Real estate	—		—		171,569		171,569
Fixed Income	—		—		90,869		90,869
Partnerships	—		—		133,379		133,379
Short-term investments and other (e)	—		1,208		98,505		99,713
Total	$	686,941	$	1,467,001	$	903,085	$	3,057,027
Other Benefits:
Cash and cash equivalents	$	143	$	—	$	—	$	143
Fixed income securities:
Corporate	—		306,008		—		306,008
U.S. Treasury	336,963		—		—		336,963
Other (b)	—		32,508		—		32,508
Common stock equities (c)	196,153		—		—		196,153
Mutual funds (d)	39,269		—		—		39,269
Common and collective trusts:
Equities	—		—		75,310		75,310
Real estate	—		—		15,422		15,422
Short-term investments and other (e)	11,268		149		9,178		20,595
Total	$	583,796	$	338,665	$	99,910	$	1,022,371


(a)	These investments primarily represent assets valued using net asset value as a practical expedient, and have not been classified in the fair value hierarchy.


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


(c)	This category primarily consists of U.S. common stock equities.


(d)	These funds invest in U.S. and international common stock equities.


(e)	This category includes plan receivables and payables.

The fair value of Pinnacle West’s pension plan and other postretirement benefit plan assets at December 31, 2016, 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)		Other (a)		Balance at December 31, 2016
Pension Plan:
Cash and cash equivalents	$	13,995	$	—	$	—	$	13,995
Fixed income securities:
Corporate	—		1,210,453		—		1,210,453
U.S. Treasury	112,583		—		—		112,583
Other (b)	—		102,170		—		102,170
Common stock equities (c)	235,109		—		—		235,109
Mutual funds (d)	251,506		—		—		251,506
Common and collective trusts:
Equities	—		—		266,840		266,840
Real estate	—		—		161,449		161,449
Partnerships	—		—		208,915		208,915
Short-term investments and other (e)	—		—		112,337		112,337
Total	$	613,193	$	1,312,623	$	749,541	$	2,675,357
Other Benefits:
Cash and cash equivalents	$	304	$	—	$	—	$	304
Fixed income securities:
Corporate	—		268,193		—		268,193
U.S. Treasury	145,255		—		—		145,255
Other (b)	—		34,506		—		34,506
Common stock equities (c)	243,741		—		—		243,741
Mutual funds (d)	67,418		—		—		67,418
Common and collective trusts:
Equities	—		—		95,814		95,814
Real estate	—		—		14,509		14,509
Partnerships	—		—		3,060		3,060
Short-term investments and other (e)	—		—		9,851		9,851
Total	$	456,718	$	302,699	$	123,234	$	882,651


(a)	These investments primarily represent assets valued using net asset value as a practical expedient, and have not been classified in the fair value hierarchy.


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


(c)	This category primarily consists of U.S. common stock equities.


(d)	These funds invest in U.S. and international common stock equities.


(e)	This category includes plan receivables and payables.

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 2017, $100 million in 2016, and $100 million in 2015. 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 $250 million during the 2018-2020 period. With regard to contributions to our other postretirement benefit plans, we made a contribution of approximately $1 million in each of 2017, 2016 and 2015. We do not expect to make any contributions over 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 approximately $100 million in 2017, $100 million in 2016 and $100 million in 2015. APS’s share of the contributions to the other postretirement benefit plan was approximately $1 million in 2017, 2016 and 2015.

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
2018	$	175,383	$	31,891
2019	181,902		34,000
2020	191,586		35,658
2021	196,583		37,090
2022	201,463		37,860
Years 2023-2027	1,068,568		191,207

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 2017, 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 $10 million for 2017, $10 million for 2016, and $9 million for 2015.