Employee Benefit Plans

Pension and Other Postretirement Benefit Plans

We sponsor and/or contribute to pension and postretirement health care and life insurance benefit plans for eligible employees, which includes two cash balance pension plans. The plan for our South Dakota and Nebraska employees is referred to as the NorthWestern pension plan, and the plan for our Montana employees is referred to as the NorthWestern Energy pension plan. We utilize a number of accounting mechanisms that reduce the volatility of reported pension costs. Differences between actuarial assumptions and actual plan results are deferred and are recognized into earnings only when the accumulated differences exceed 10% of the greater of the projected benefit obligation or the market-related value of plan assets. If necessary, the excess is amortized over the average remaining service period of active employees. The Plan’s funded status is recognized as an asset or liability in our financial statements. See Note 17 - Regulatory Assets and Liabilities, for further discussion on how these costs are recovered through rates charged to our customers.

Benefit Obligation and Funded Status

Following is a reconciliation of the changes in plan benefit obligations and fair value of plan assets, and a statement of the funded status (in thousands):



	Pension Benefits						Other Postretirement Benefits
	December 31,						December 31,
	2012			2011			2012			2011
Change in Benefit Obligation:
Obligation at beginning of period	$	536,536		$	478,790		$	32,427		$	35,968
Service cost	11,488			10,199			541			437
Interest cost	23,823			24,394			1,167			1,348
Plan amendments	—			—			—			(464		)
Actuarial loss (gain)	59,071			44,586			2,508			(2,056		)
Benefits paid	(21,275		)	(21,433		)	(2,603		)	(2,806		)
Benefit obligation at end of period	$	609,643		$	536,536		$	34,040		$	32,427
Change in Fair Value of Plan Assets:
Fair value of plan assets at beginning of period	$	432,637		$	428,152		$	15,502		$	17,201
Return on plan assets	49,874			14,218			1,789			340
Employer contributions	11,700			11,700			1,205			767
Benefits paid	(21,275		)	(21,433		)	(2,603		)	(2,806		)
Fair value of plan assets at end of period	$	472,936		$	432,637		$	15,893		$	15,502
Funded Status	$	(136,707	)	$	(103,899	)	$	(18,147	)	$	(16,925	)
Amounts recognized in the balance sheet consist of:
Current liability	—			—			(1,082		)	(1,075		)
Noncurrent liability	(136,707		)	(103,899		)	(17,065		)	(15,850		)
Net amount recognized	$	(136,707	)	$	(103,899	)	$	(18,147	)	$	(16,925	)
Amounts recognized in regulatory assets consist of:
Prior service (cost) credit	(994		)	(1,241		)	21,396			23,545
Net actuarial loss	(160,610		)	(130,062		)	(9,488		)	(10,025		)
Amounts recognized in AOCI consist of:
Prior service cost	—			—			(1,453		)	(1,604		)
Net actuarial gain	—			—			(2,432		)	(1,051		)
Total	$	(161,604	)	$	(131,303	)	$	8,023		$	10,865

The total projected benefit obligation and fair value of plan assets for the pension plans with accumulated benefit obligations in excess of plan assets were as follows (in millions):



	Pension Benefits
	December 31,
	2012		2011
Projected benefit obligation	$	609.6	$	536.5
Accumulated benefit obligation	606.2		533.5
Fair value of plan assets	472.9		432.6

Net Periodic Cost (Credit)

The components of the net costs (credits) for our pension and other postretirement plans are as follows (in thousands):



	Pension Benefits									Other Postretirement Benefits
	December 31,									December 31,
	2012			2011			2010			2012			2011			2010
Components of Net Periodic Benefit Cost
Service cost	$	11,488		$	10,199		$	9,361		$	541		$	437		$	483
Interest cost	23,823			24,394			24,090			1,167			1,348			1,803
Expected return on plan assets	(29,996		)	(30,462		)	(29,839		)	(1,021		)	(1,185		)	(1,186		)
Amortization of prior service cost (credit)	246			246			246			(1,998		)	(1,998		)	(1,952		)
Recognized actuarial loss	8,646			2,516			140			790			658			984
Net Periodic Benefit Cost (Credit)	$	14,207		$	6,893		$	3,998		$	(521	)	$	(740	)	$	132

For purposes of calculating the expected return on pension plan assets, the market-related value of assets is used, which is based upon fair value. The difference between actual plan asset returns and estimated plan asset returns are amortized equally over a period not to exceed five years.

We estimate amortizations from regulatory assets into net periodic benefit cost during 2013 will be as follows (in thousands):



	Pension Benefits		Other Postretirement Benefits
Prior service cost (credit)	$	246	$	(1,998	)
Accumulated loss	10,984		901

Actuarial Assumptions

The measurement dates used to determine pension and other postretirement benefit measurements for the plans are December 31, 2012 and 2011. The actuarial assumptions used to compute net periodic pension cost and postretirement benefit cost are based upon information available as of the beginning of the year, specifically, market interest rates, past experience and management's best estimate of future economic conditions. Changes in these assumptions may impact future benefit costs and obligations. In computing future costs and obligations, we must make assumptions about such things as employee mortality and turnover, expected salary and wage increases, discount rate, expected return on plan assets, and expected future cost increases. Two of these assumptions have the most impact on the level of cost: (1) discount rate and (2) expected rate of return on plan assets.

For 2012 and 2011, we set the discount rate using a yield curve analysis, which projects benefit cash flows into the future and then discounts those cash flows to the measurement date using a yield curve. This is done by constructing a hypothetical bond portfolio whose cash flow from coupons and maturities matches the year-by-year, projected benefit cash flow from our plans.

In determining the expected long-term rate of return on plan assets, we review historical returns, the future expectations for returns for each asset class weighted by the target asset allocation of the pension and postretirement portfolios, and long-term inflation assumptions. Considering this information and future expectations for asset returns, we are maintaining a 7.00% long-term rate of return on assets assumption for 2013.

The health care cost trend rates are established through a review of actual recent cost trends and projected future trends. Our retiree medical trend assumptions are the best estimate of expected inflationary increases to our healthcare costs. Due to the relative size of our retiree population (under 800 members), the assumptions used are based upon both nationally expected trends and our specific expected trends. Our average increase remains consistent with the nationally expected trends.

The weighted-average assumptions used in calculating the preceding information are as follows:



	Pension Benefits						Other Postretirement Benefits
	December 31,						December 31,
	2012		2011		2010		2012		2011		2010
Discount rate	3.55-3.80	%	4.40-4.55	%	5.00-5.25	%	2.25-3.20	%	3.50-4.30	%	4.00-5.00	%
Expected rate of return on assets	7.00		7.25		7.75		7.00		7.25		7.75
Long-term rate of increase in compensation levels (nonunion)	3.58		3.58		3.58		3.58		3.58		3.58
Long-term rate of increase in compensation levels (union)	3.50		3.50		3.50		3.50		3.50		3.50

The postretirement benefit obligation is calculated assuming that health care costs increased by 8.75% in 2012 and the rate of increase in the per capita cost of covered health care benefits thereafter was assumed to decrease gradually by 0.25% per year to an ultimate trend of 4.5% by the year 2029. The company contribution toward the premium cost is capped, therefore future health care cost trend rates are expected to have a minimal impact on company costs and the accumulated postretirement benefit obligation.

Investment Strategy

Our investment goals with respect to managing the pension and other postretirement assets are to meet current and future benefit payment needs while maximizing total investment returns (income and appreciation) after inflation within the constraints of diversification, prudent risk taking, and the Prudent Man Rule of the Employee Retirement Income Security Act of 1974. Each plan is diversified across asset classes to achieve optimal balance between risk and return and between income and growth through capital appreciation. Our investment philosophy is based on the following:


•	Each plan should be substantially fully invested as long-term cash holdings reduce long-term rates of return;


•	It is prudent to diversify each plan across the major asset classes;


•	Equity investments provide greater long-term returns than fixed income investments, although with greater short-term volatility;


•	Fixed income investments of the plans should strongly correlate with the interest rate sensitivity of the plan’s aggregate liabilities in order to hedge the risk of change in interest rates negatively impacting the overall funded status;


•	Allocation to foreign equities increases the portfolio diversification and thereby decreases portfolio risk while providing for the potential for enhanced long-term returns;


•	Active management can reduce portfolio risk and potentially add value through security selection strategies;


•	A portion of plan assets should be allocated to passive, indexed management funds to provide for greater diversification and lower cost; and


•	It is appropriate to retain more than one investment manager, provided that such managers offer asset class or style diversification.

Investment risk is measured and monitored on an ongoing basis through quarterly investment portfolio reviews, annual liability measurements, and periodic asset/liability studies.

The most important component of an investment strategy is the portfolio asset mix, or the allocation between the various classes of securities available. The mix of assets is based on an optimization study that identifies asset allocation targets in order to achieve the maximum return for an acceptable level of risk, while minimizing the expected contributions and pension and postretirement expense. In the optimization study, assumptions are formulated about characteristics, such as expected asset class investment returns, volatility (risk), and correlation coefficients among the various asset classes, and making adjustments to reflect future conditions expected to prevail over the study period. Based on this, the target asset allocation established, within an allowable range of plus or minus 5%, is as follows:



	Pension Benefits				Other Benefits
	December 31,				December 31,
	2012		2011		2012		2011
Domestic debt securities	40.0	%	40.0	%	40.0	%	40.0	%
International debt securities	10.0		10.0		—		—
Domestic equity securities	40.0		40.0		50.0		50.0
International equity securities	10.0		10.0		10.0		10.0

The actual allocation by plan is as follows:



	NorthWestern Energy Pension				NorthWestern Pension				NorthWestern Energy Health and Welfare
	December 31,				December 31,				December 31,
	2012		2011		2012		2011		2012		2011
Cash and cash equivalents	—	%	—	%	—	%	—	%	3.4	%	2.0	%
Domestic debt securities	39.5		39.5		38.3		38.4		37.8		39.4
International debt securities	9.9		10.6		10.6		11.2		—		—
Domestic equity securities	40.2		40.3		40.6		40.9		49.8		49.8
International equity securities	10.4		9.6		10.5		9.5		9.0		8.8
	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%

Generally, the asset mix will be rebalanced to the target mix as individual portfolios approach their minimum or maximum levels. Debt securities consist of U.S. and international instruments. Core domestic portfolios can be invested in government, corporate, asset-backed and mortgage-backed obligation securities. While the portfolio may invest in high yield securities, the average quality must be rated at least “investment grade" by rating agencies. Performance of fixed income investments is measured by both traditional investment benchmarks as well as relative changes in the present value of the plan's liabilities. Equity investments consist primarily of U.S. stocks including large, mid and small cap stocks, which are diversified across investment styles such as growth and value. We also invest in international equities with exposure to developing and emerging markets. Derivatives, options and futures are permitted for the purpose of reducing risk but may not be used for speculative purposes.

Our plan assets are primarily invested in common collective trusts (CCTs), which are invested in equity and fixed income securities. In accordance with our investment policy, these pooled investment funds must have an adequate asset base relative to their asset class and be invested in a diversified manner and have a minimum of three years of verified investment performance experience or verified portfolio manager investment experience in a particular investment strategy and have management and oversight by an investment advisor registered with the SEC. Investments in a collective investment vehicle are valued by multiplying the investee company’s net asset value per share with the number of units or shares owned at the valuation date. Net asset value per share is determined by the trustee. Investments held by the CCT, including collateral invested for securities on loan, are valued on the basis of valuations furnished by a pricing service approved by the CCT’s investment manager, which determines valuations using methods based on quoted closing market prices on national securities exchanges, or at fair value as determined in good faith by the CCT’s investment manager if applicable. The funds do not contain any redemption restrictions. The direct holding of NorthWestern Corporation stock is not permitted; however, any holding in a diversified mutual fund or collective investment fund is permitted. In addition, the NorthWestern Corporation pension plan assets also include a participating group annuity contract in the John Hancock General Investment Account, which consists primarily of fixed-income securities. The participating group annuity contract is valued based on discounted cash flows of current yields of similar contracts with comparable duration based on the underlying fixed income investments.

The fair value of our plan assets at December 31, 2012, by asset category are as follows (in thousands):



Asset Category	Total		Quoted Market Prices in Active Markets for Identical Assets Level 1		Significant Observable Inputs Level 2		Significant Unobservable Inputs Level 3
Pension Plan Assets
Cash and cash equivalents	$	508			$	508	$	—
Equity securities: (1)
US small/mid cap growth	16,229		—		16,229		—
US small/mid cap value	16,297		—		16,297		—
US large cap growth	49,811		—		49,811		—
US large cap value	51,655		—		51,655		—
US large cap passive	56,194		—		56,194		—
Non-US core	36,358		—		36,358		—
Emerging markets	12,713		—		12,713		—
Fixed income securities:(2)
US core opportunistic	90,742		—		90,742		—
US passive	48,710		—		48,710		—
Long duration	6,455		—		6,455		—
Long duration investment grade	7,091		—		7,091		—
Long duration passive	5,239		—		5,239		—
Non-US passive	46,856		—		46,856		—
Active long corporate	18,540		—		18,540		—
Participating group annuity contract	9,538		—		9,538		—
	$	472,936	$	—	$	472,936	$	—
Other Postretirement Benefit Plan Assets
Cash and cash equivalents	$	533	$	—	$	533	$	—
Equity securities: (1)
US small/mid cap growth	567		—		567		—
US small/mid cap value	567		—		567		—
S&P 500 index	6,360		—		6,360		—
US large cap growth	132		—		132		—
US large cap value	139		—		139		—
US large cap passive	151		—		151		—
Non-US core	1,323		—		1,323		—
Emerging markets	108		—		108		—
Fixed income securities: (2)
Passive bond market	1,205		—		1,205		—
US core opportunistic	4,440		—		4,440		—
US passive	138		—		138		—
Long duration	16		—		16		—
Long duration investment grade	21		—		21		—
Long duration passive	16		—		16		—
Non-US passive	124		—		124		—
Active long corporate	53		—		53		—
	$	15,893	$	—	$	15,893	$	—

The fair value of our plan assets at December 31, 2011, by asset category are as follows (in thousands):



Asset Category	Total		Quoted Market Prices in Active Markets for Identical Assets Level 1		Significant Observable Inputs Level 2		Significant Unobservable Inputs Level 3
Pension Plan Assets
Cash and cash equivalents	$	313	$	—	$	313	$	—
Equity securities: (1)
US small/mid cap growth	14,922		—		14,922		—
US small/mid cap value	15,290		—		15,290		—
US large cap growth	43,786		—		43,786		—
US large cap value	46,248		—		46,248		—
US large cap passive	54,477		—		54,477		—
Non-US core	41,270		—		41,270		—
Fixed income securities:(2)
US core opportunistic	80,702		—		80,702		—
US passive	41,630		—		41,630		—
Long duration	6,998		—		6,998		—
Long duration investment grade	13,058		—		13,058		—
Long duration passive	5,441		—		5,441		—
Non-US passive	46,023		—		46,023		—
Active long corporate	12,730		—		12,730		—
Participating group annuity contract	9,749		—		9,749		—
	$	432,637	$	—	$	432,637	$	—
Other Postretirement Benefit Plan Assets
Cash and cash equivalents	$	270	—		$	270	—
Equity securities: (1)
US small/mid cap growth	643		—		643		—
US small/mid cap value	636		—		636		—
S&P 500 index	5,671		—		5,671		—
US large cap growth	180		—		180		—
US large cap value	192		—		192		—
US large cap passive	227		—		227		—
Non-US core	1,379		—		1,379		—
Fixed income securities: (2)
Passive bond market	1,156		—		1,156		—
US core opportunistic	4,603		—		4,603		—
US passive	185		—		185		—
Long duration	25		—		25		—
Long duration investment grade	61		—		61		—
Long duration passive	26		—		26		—
Non-US passive	191		—		191		—
Active long corporate	57		—		57		—
	$	15,502	$	—	$	15,502	$	—

_________________


(1)	This category consists of active and passive managed equity funds, which are invested in multiple strategies to diversify risks and reduce volatility.

(2) This category consists of investment grade bonds of issuers from diverse industries, debt securities issued by international, national, state and local governments, and asset-backed securities. This includes both active and passive managed funds.

For further discussion of the three levels of the fair value hierarchy see Note 9 - Fair Value Measurements.

Cash Flows

In accordance with the Pension Protection Act of 2006 (PPA), and the relief provisions of the Worker, Retiree, and Employer Recovery Act of 2008 (WRERA), we are required to meet minimum funding levels in order to avoid required contributions and benefit restrictions. We have elected to use asset smoothing provided by the WRERA, which allows the use of asset averaging, including expected returns (subject to certain limitations), for a 24-month period in the determination of funding requirements.

Based on the assumptions allowed under the PPA, WRERA, Treasury guidance and IRS guidance, we estimate that we will not have a minimum annual required contribution for 2013. We do expect to contribute approximately $11.7 million to our pension plans during 2013. Additional legislative or regulatory measures, as well as fluctuations in financial market conditions, may impact these funding requirements.

Due to the regulatory treatment of pension costs in Montana, expense is calculated using the average of our actual and estimated funding amounts from 2005 through 2013, therefore changes in our funding estimates creates increased volatility to earnings. Annual contributions to each of the pension plans are as follows (in thousands):



	2012		2011		2010
NorthWestern Energy Pension Plan (MT)	$	10,500	$	10,500	$	9,000
NorthWestern Pension Plan (SD)	1,200		1,200		1,000
	$	11,700	$	11,700	$	10,000

We estimate the plans will make future benefit payments to participants as follows (in thousands):



	Pension Benefits		Other Postretirement Benefits
2013	$	25,180	$	3,686
2014	26,439		3,639
2015	27,694		3,544
2016	29,682		3,438
2017	30,823		3,212
2018-2022	173,402		12,636

Defined Contribution Plan

Our defined contribution plan permits employees to defer receipt of compensation as provided in Section 401(k) of the Internal Revenue Code. Under the plan, employees may elect to direct a percentage of their gross compensation to be contributed to the plan. We contribute various percentage amounts of the employee's gross compensation contributed to the plan. Matching contributions for the year ended December 31, 2012, 2011 and 2010 were $7.2 million, $6.7 million, and $6.0 million, respectively.