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Retirement Plans and Other Benefits

12 Months Ended

Dec. 31, 2018

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.

Because of plan changes in 2014, the Company sought 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, which is included in the other special use funds on the Consolidated Balance Sheets. The Company and the IRS executed a final Closing Agreement on March 2, 2018. The Company made an informational filing with FERC during February 2018. It is the Company’s understanding that completion of these regulatory requirements permits access to 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.

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 or billed to electric plant participants) (dollars in thousands):



	Pension									Other Benefits
	2018			2017			2016			2018			2017			2016
Service cost-benefits earned during the period	$	56,669		$	54,858		$	53,792		$	21,100		$	17,119		$	14,993
Interest cost on benefit obligation	124,689			129,756			131,647			28,147			29,959			29,721
Expected return on plan assets	(182,853		)	(174,271		)	(173,906		)	(42,082		)	(53,401		)	(36,495		)
Amortization of:
Prior service cost (credit)	—			81			527			(37,842		)	(37,842		)	(37,883		)
Net actuarial loss	32,082			47,900			40,717			—			5,118			4,589
Net periodic benefit cost (benefit)	$	30,587		$	58,324		$	52,777		$	(30,677	)	$	(39,047	)	$	(25,075	)
Portion of cost charged to expense	$	10,120		$	27,295		$	26,172		$	(21,426	)	$	(18,274	)	$	(12,435	)

On January 1, 2018, we adopted new accounting standard ASU 2017-07, Compensation-Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This new standard changed our income statement presentation of net periodic benefit cost/(credits) and allows only the service cost component of net periodic benefit cost to be eligible for capitalization. See Note 2 for additional information.

The following table shows the plans’ changes in the benefit obligations and funded status for the years 2018 and 2017 (dollars in thousands):



	Pension						Other Benefits
	2018			2017			2018			2017
Change in Benefit Obligation
Benefit obligation at January 1	$	3,394,186		$	3,204,462		$	753,393		$	716,445
Service cost	56,669			54,858			21,100			17,119
Interest cost	124,689			129,756			28,147			29,959
Benefit payments	(184,161		)	(166,342		)	(31,540		)	(30,144		)
Actuarial (gain) loss	(200,757		)	171,452			(94,329		)	20,014
Benefit obligation at December 31	3,190,626			3,394,186			676,771			753,393
Change in Plan Assets
Fair value of plan assets at January 1	3,057,027			2,675,357			1,022,371			882,651
Actual return on plan assets	(201,078		)	428,374			(40,354		)	139,367
Employer contributions	50,000			100,000			—			353
Benefit payments	(172,473		)	(146,704		)	(72,453		)	—
Transfer to active union medical account	—			—			(185,887		)	—
Fair value of plan assets at December 31	2,733,476			3,057,027			723,677			1,022,371
Funded Status at December 31	$	(457,150	)	$	(337,159	)	$	46,906		$	268,978

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, 2018 and 2017 (dollars in thousands):



	2018		2017
Projected benefit obligation	$	3,190,626	$	3,394,186
Accumulated benefit obligation	3,038,774		3,227,233
Fair value of plan assets	2,733,476		3,057,027

The following table shows the amounts recognized on the Consolidated Balance Sheets as of December 31, 2018 and 2017 (dollars in thousands):



	Pension						Other Benefits
	2018			2017			2018		2017
Noncurrent asset	$	—		$	—		$	46,906	$	268,978
Current liability	(13,980		)	(9,859		)	—		—
Noncurrent liability	(443,170		)	(327,300		)	—		—
Net amount recognized	$	(457,150	)	$	(337,159	)	$	46,906	$	268,978

The following table shows the details related to accumulated other comprehensive loss as of December 31, 2018 and 2017 (dollars in thousands):



	Pension						Other Benefits
	2018			2017			2018			2017
Net actuarial loss	$	794,292		$	643,199		$	63,544		$	75,439
Prior service credit	—			—			(227,733		)	(265,575		)
APS’s portion recorded as a regulatory (asset) liability	(733,351		)	(576,188		)	163,767			189,627
Income tax expense (benefit)	(15,083		)	(24,915		)	561			853
Accumulated other comprehensive loss	$	45,858		$	42,096		$	139		$	344

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 2019 (dollars in thousands):



	Pension		Other Benefits
Net actuarial loss	$	43,248	$	—
Prior service credit	—		(37,821		)
Total amounts estimated to be amortized from accumulated other comprehensive loss (gain) and regulatory assets (liabilities) in 2019	$	43,248	$	(37,821	)

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,
	2018		2017		2018		2017		2016
Discount rate – pension	4.34	%	3.65	%	3.65	%	4.08	%	4.37	%
Discount rate – other benefits	4.39	%	3.71	%	3.71	%	4.17	%	4.52	%
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		6.05	%	6.55	%	6.90	%
Expected long-term return on plan assets - other benefits	N/A		N/A		5.40	%	6.05	%	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	%	4.75	%	4.75	%	5.00	%	5.00	%
Ultimate healthcare cost trend rate	4.75	%	4.75	%	4.75	%	5.00	%	5.00	%
Number of years to ultimate trend rate (pre-65 participants)	7		8		8		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 2019, we are assuming a 6.25% 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, 2018 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	$	10,235	$	(4,322	)
Effect on service and interest cost components of net periodic other postretirement benefit costs	11,223		(8,479		)
Effect on the accumulated other postretirement benefit obligation	101,224		(81,144		)

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 2018, the target and actual allocation for the pension plan at December 31, 2018 are as follows:



	Pension
	Target Allocation		Actual Allocation
Long-term fixed income assets	62	%	64	%
Return-generating assets	38	%	36	%
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, 2018, 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, 2018:



	Other Benefits
	Actual Allocation
Long-term fixed income assets	69	%
Return-generating assets	31	%
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 Futures 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, 2018, 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, 2018, approximately $62 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, 2018, 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, 2018
Pension Plan:
Cash and cash equivalents	$	451	$	—	$	—	$	451
Fixed income securities:
Corporate	—		1,237,744		—		1,237,744
U.S. Treasury	372,649		—		—		372,649
Other (b)	—		78,902		—		78,902
Common stock equities (c)	196,661		—		—		196,661
Mutual funds (d)	120,976		—		—		120,976
Common and collective trusts:
Equities	—		—		272,926		272,926
Real estate	—		—		165,123		165,123
Fixed Income	—		—		86,483		86,483
Partnerships	—		—		125,217		125,217
Short-term investments and other (e)	—		—		76,344		76,344
Total	$	690,737	$	1,316,646	$	726,093	$	2,733,476
Other Benefits:
Cash and cash equivalents	$	93	$	—	$	—	$	93
Fixed income securities:
Corporate	—		163,286		—		163,286
U.S. Treasury	318,017		—		—		318,017
Other (b)	—		7,531		—		7,531
Common stock equities (c)	129,199		—		—		129,199
Mutual funds (d)	10,963		—		—		10,963
Common and collective trusts:
Equities	—		—		65,720		65,720
Real estate	—		—		19,054		19,054
Short-term investments and other (e)	3,633		—		6,181		9,814
Total	$	461,905	$	170,817	$	90,955	$	723,677


(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 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, 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.

Contributions

Future year contribution amounts are dependent on plan asset performance and plan actuarial assumptions. We made contributions to our pension plan totaling $50 million in 2018, $100 million in 2017, and $100 million in 2016. 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 $350 million during the 2019-2021 period.

With regard to contributions to our other postretirement benefit plan, we did not make a contribution in 2018. We made a contribution of approximately $1 million in each of 2017 and 2016. We do not expect to make any contributions over the next three years to our other postretirement benefit plans. In 2018, the Company was reimbursed $72 million for prior years retiree medical claims from the other postretirement benefit plan trust assets.

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
2019	$	188,492	$	32,622
2020	193,087		34,199
2021	198,471		35,551
2022	204,399		36,673
2023	211,346		37,405
Years 2024-2028	1,093,319		187,023

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 2018, 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 $11 million for 2018, $10 million for 2017, and $10 million for 2016.