8. Retirement Plans and Other 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. Generally, 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.

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 14 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. 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 3 years beginning in July 2012. We amortized approximately $8 million during 2013 and $4 million during 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) (dollars in thousands):

	Pension									Other Benefits
	2013			2012			2011			2013			2012			2011
Service cost-benefits earned during the period	$	64,195		$	63,502		$	57,605		$	23,597		$	27,163		$	21,856
Interest cost on benefit obligation	112,392			119,586			124,727			41,536			46,467			46,807
Expected return on plan assets	(146,333		)	(140,979		)	(133,678		)	(45,717		)	(45,793		)	(41,536		)
Amortization of:
Transition obligation	—			—			—			—			452			452
Prior service cost (credit)	1,097			1,143			1,400			(179		)	(179		)	(179		)
Net actuarial loss	39,852			44,250			25,956			11,310			20,233			15,015
Net periodic benefit cost	$	71,203		$	87,502		$	76,010		$	30,547		$	48,343		$	42,415
Portion of cost charged to expense	$	38,968		$	36,333		$	29,312		$	18,469		$	19,321		$	15,208

The following table shows the plans’ changes in the benefit obligations and funded status for the years 2013 and 2012 (dollars in thousands):

	Pension						Other Benefits
	2013			2012			2013			2012
Change in Benefit Obligation
Benefit obligation at January 1	$	2,850,846		$	2,699,126		$	990,418		$	1,047,094
Service cost	64,195			63,502			23,597			27,163
Interest cost	112,392			119,586			41,536			46,467
Benefit payments	(125,269		)	(113,632		)	(26,675		)	(26,279		)
Actuarial (gain) loss	(255,634		)	82,264			(138,458		)	(104,027		)
Benefit obligation at December 31	2,646,530			2,850,846			890,418			990,418

Change in Plan Assets
Fair value of plan assets at January 1	2,079,181			1,850,550			684,221			608,663
Actual return on plan assets	150,546			259,363			76,995			83,567
Employer contributions	140,500			65,000			14,438			22,707
Benefit payments	(106,106		)	(95,732		)	(27,315		)	(30,716		)
Fair value of plan assets at December 31	2,264,121			2,079,181			748,339			684,221
Funded Status at December 31	$	(382,409	)	$	(771,665	)	$	(142,079	)	$	(306,197	)

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, 2013 and 2012 (dollars in thousands):

	2013		2012
Projected benefit obligation	$	2,646,530	$	2,850,846
Accumulated benefit obligation	2,469,889		2,646,306
Fair value of plan assets	2,264,121		2,079,181

The following table shows the amounts recognized on the Consolidated Balance Sheets as of December 31, 2013 and 2012 (dollars in thousands):

	Pension						Other Benefits
	2013			2012			2013			2012
Current liability	$	(10,860	)	$	(19,107	)	$	—		$	—
Noncurrent liability	(371,549		)	(752,558		)	(142,079		)	(306,197		)
Net amount recognized	$	(382,409	)	$	(771,665	)	$	(142,079	)	$	(306,197	)

The following table shows the details related to accumulated other comprehensive loss as of December 31, 2013 and 2012 (dollars in thousands):

	Pension						Other Benefits
	2013			2012			2013			2012
Net actuarial loss	$	344,540		$	644,239		$	57,816		$	238,862
Prior service cost (credit)	2,072			3,169			(296		)	(475		)
APS’s portion recorded as a regulatory asset	(265,107		)	(550,471		)	(49,298		)	(230,020		)
Income tax benefit	(32,204		)	(38,303		)	(2,528		)	(2,585		)
Accumulated other comprehensive loss	$	49,301		$	58,634		$	5,694		$	5,782

The following table shows the estimated amounts that will be amortized from accumulated other comprehensive loss and regulatory assets into net periodic benefit cost in 2014 (dollars in thousands):

	Pension		Other Benefits
Net actuarial loss	$	8,363	$	—
Prior service cost (credit)	874		(179		)
Total amounts estimated to be amortized from accumulated other comprehensive loss and regulatory assets in 2014	$	9,237	$	(179	)

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,
	2013		2012		2013		2012		2011
Discount rate – pension	4.88	%	4.01	%	4.01	%	4.42	%	5.31	%
Discount rate – other benefits	5.10	%	4.20	%	4.20	%	4.59	%	5.49	%
Rate of compensation increase	4.00	%	4.00	%	4.00	%	4.00	%	4.00	%
Expected long-term return on plan assets	N/A		N/A		7.00	%	7.75	%	7.75	%
Initial healthcare cost trend rate	7.50	%	7.50	%	7.50	%	7.50	%	8.00	%
Ultimate healthcare cost trend rate	5.00	%	5.00	%	5.00	%	5.00	%	5.00	%
Number of years to ultimate trend rate	4		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 2014, we are assuming a 6.9% long-term rate of return for pension assets and 7.1% (before tax) for other benefit assets, which we believe is reasonable given our asset allocation in relation to historical and expected performance.

The assumed healthcare cost trend rates shown above have a significant effect on the amounts reported for the healthcare plans. 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 millions):

	1% Increase		1% Decrease
Effect on other postretirement benefits expense, after consideration of amounts capitalized or billed to electric plant participants	$	13	$	(10	)
Effect on service and interest cost components of net periodic other postretirement benefit costs	14		(11		)
Effect on the accumulated other postretirement benefit obligation	149		(120		)

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 common and collective trusts.

Based on the IPS, and given the pension plan’s funded status at year-end 2013, 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 45% to 39%. 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, 2013, long-term fixed income assets represented 55% of total pension plan assets, and return-generating assets represented 45% of total pension plan assets.

The asset allocation for other postretirement benefit plan assets is governed by the IPS for those plans, which provides for an asset allocation target mix of generally 25% of fixed income assets and 75% of non-fixed income assets. This asset allocation target mix does not vary with the plan’s funded status. As of December 31, 2013, investment in fixed income assets represented 38% of the other postretirement benefit plan total assets, and non-fixed income assets represented 62% 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 14 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 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.

The common and collective trusts, which are similar to mutual funds, 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). Common and collective trusts are valued using the concept of net asset value (“NAV”), which is a value derived from the quoted active market prices of the underlying securities. The plans’ common and collective real estate trust is valued using NAV, which is derived from the appraised values of the trust’s underlying real estate assets. As of December 31, 2013, the plans were able to transact in the common and collective trusts at NAV and accordingly classify these investments as Level 2. Because the trust’s shares are offered to a limited group of investors, they are not considered to be traded in an active market.

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, 2013, 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 (c)		Balance at December 31, 2013
Pension Plan:
Assets:
Cash and cash equivalents	$	504	$	—	$	—		$	—	$	504
Fixed Income Securities:
Corporate	—		898,621		—			—		898,621
U.S. Treasury	231,590		—		—			—		231,590
Other (b)	—		84,011		—			—		84,011
Equities:
U.S. Companies	239,036		—		—			—		239,036
International Companies	19,429		—		—			—		19,429
Common and collective trusts:
U.S. Equities	—		116,150		—			—		116,150
International Equities	—		367,551		—			—		367,551
Fixed Income			137,520							137,520
Real estate	—		119,739		—			—		119,739
Short-term investments and other	—		41,060		8,660		(a)	250		49,970

Total Pension Plan	$	490,559	$	1,764,652	$	8,660		$	250	$	2,264,121
Other Benefits:
Assets:
Fixed Income Securities:
Corporate	$	—	$	153,888	$	—		$	—	$	153,888
U.S. Treasury	98,704		—		—			—		98,704
Other (b)	—		27,936		—			—		27,936
Equities:
U.S. Companies	252,181		—		—			—		252,181
International Companies	20,892		—		—			—		20,892
Common and collective trusts:
U.S. Equities	—		80,751		—			—		80,751
International Equities	—		92,382		—			—		92,382
Real Estate	—		10,761		—			—		10,761
Short-term investments and other	—		8,414		—			2,430		10,844

Total Other Benefits	$	371,777	$	374,132	$	—		$	2,430	$	748,339

(a) Represents investments in a partnership that invests in privately held portfolio companies.

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

The fair value of Pinnacle West’s pension plan and other postretirement benefit plan assets at December 31, 2012, 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 (c)			Balance at December 31, 2012
Pension Plan:
Assets:
Cash and cash equivalents	$	579	$	—	$	—		$	—		$	579
Fixed Income Securities:
Corporate	—		607,749		—			—			607,749
U.S. Treasury	232,161		—		—			—			232,161
Other (b)	—		67,992		—			—			67,992
Equities:
U.S. Companies	531,291		—		—			—			531,291
International Companies	43,848		—		—			—			43,848
Common and collective trusts:
U.S. Equities	—		176,694		—			—			176,694
International Equities	—		271,735		—			—			271,735
Real estate	—		117,854		—			—			117,854
Short-term investments and other	—		26,922		2,419		(a)	(63		)	29,278

Total Pension Plan	$	807,879	$	1,268,946	$	2,419		$	(63	)	$	2,079,181
Other Benefits:
Assets:
Cash and cash equivalents	$	60	$	—	$	—		$	—		$	60
Fixed Income Securities:
Corporate	—		163,306		—			—			163,306
U.S. Treasury	112,558		—		—			—			112,558
Other (b)	—		33,998		—			—			33,998
Equities:
U.S. Companies	205,714		—		—			—			205,714
International Companies	14,412		—		—			—			14,412
Common and collective trusts:
U.S. Equities	—		60,038		—			—			60,038
International Equities	—		76,969		—			—			76,969
Real Estate	—		9,378		—			—			9,378
Short-term investments and other	402		6,340		—			1,046			7,788

Total Other Benefits	$	333,146	$	350,029	$	—		$	1,046		$	684,221

(a) Represents investments in a partnership that invests in privately held portfolio companies.

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

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, 2013 and 2012 (dollars in thousands):

	Pension
Short-Term Investments and Other	2013			2012
Beginning balance at January 1	$	2,419		$	—
Actual return on assets still held at December 31	(498		)	(668		)
Purchases, sales, and settlements	6,739			3,087
Transfers in and/or out of Level 3	—			—
Ending balance at December 31	$	8,660		$	2,419

Contributions

Future year contribution amounts are dependent on plan asset performance and plan actuarial assumptions. We made contributions to our pension plan totaling $141 million in 2013, $65 million in 2012, and zero in 2011. The minimum contributions for the pension plan total $141 million for the next three years under the recently enacted Moving Ahead for Progress in the 21st Century Act (zero in 2014, $19 million in 2015, and $122 million in 2016). Instead, we expect to make voluntary contributions totaling $300 million for the next three years ($175 million in 2014, of which $70 million was already contributed in early 2014, up to $100 million in 2015, and up to $25 million in 2016). With regard to contributions to our other postretirement benefit plans, we made a contribution of approximately $14 million in 2013, $23 million in 2012, and $19 million in 2011. The contributions to our other postretirement benefit plans for 2014, 2015 and 2016 are expected to be approximately $10 million each year. APS funds its share of the contributions. APS’s share of the pension plan contribution was $140 million in 2013, $64 million in 2012, and zero in 2011. APS’s share of the contributions to the other postretirement benefit plan was $14 million in 2013, $22 million in 2012, and $19 million in 2011.

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
2014	$	129,159	$	28,664
2015	143,452		31,804
2016	149,105		34,933
2017	162,678		37,966
2018	169,064		40,972
Years 2019-2023	972,826		245,366

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 2013, 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 2013, $8 million for 2012, and $8 million for 2011.