Cummins Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

PENSION AND OTHER POSTRETIREMENT BENEFITS

PENSION AND OTHER POSTRETIREMENT BENEFITS

12 Months Ended

Dec. 31, 2015

Compensation and Retirement Disclosure [Abstract]

Pension and Other Postretirement Benefits Disclosure [Text Block]

NOTE 10. PENSION AND OTHER POSTRETIREMENT BENEFITS

Pension Plans

We sponsor several contributory and noncontributory pension plans covering substantially all employees. Generally, hourly employee pension benefits are earned based on years of service and compensation during active employment while future benefits for salaried employees are determined using a cash balance formula. However, the level of benefits and terms of vesting may vary among plans. Pension plan assets are administered by trustees and are principally invested in fixed income securities and equity securities. It is our policy to make contributions to our various qualified plans in accordance with statutory and contractual funding requirements and any additional contributions we determine are appropriate.

Obligations, Assets and Funded Status

Benefit obligation balances presented below reflect the projected benefit obligation (PBO) for our pension plans. The changes in the benefit obligations, the various plan assets, the funded status of the plans and the amounts recognized in our Consolidated Balance Sheets for our significant pension plans were as follows:



	Qualified and Non-Qualified Pension Plans
	U.S. Plans						U.K. Plans
In millions	2015			2014			2015			2014
Change in benefit obligation
Benefit obligation at the beginning of the year	$	2,579		$	2,261		$	1,522		$	1,429
Service cost	80			66			27			24
Interest cost	102			105			56			63
Actuarial loss (gain)	(76		)	301			(88		)	139
Benefits paid from fund	(139		)	(143		)	(53		)	(48		)
Benefits paid directly by employer	(13		)	(11		)	—			—
Exchange rate changes	—			—			(74		)	(85		)
Benefit obligation at end of year	$	2,533		$	2,579		$	1,390		$	1,522
Change in plan assets
Fair value of plan assets at beginning of year	$	2,713		$	2,445		$	1,724		$	1,516
Actual return on plan assets	(8		)	311			20			254
Employer contributions	70			100			107			94
Benefits paid	(139		)	(143		)	(53		)	(48		)
Exchange rate changes	—			—			(86		)	(92		)
Fair value of plan assets at end of year	$	2,636		$	2,713		$	1,712		$	1,724
Funded status (including underfunded and nonfunded plans) at end of year	$	103		$	134		$	322		$	202
Amounts recognized in consolidated balance sheets
Pension assets - long term	$	413		$	435		$	322		$	202
Accrued compensation, benefits and retirement costs - current liabilities	(12		)	(12		)	—			—
Pensions - long-term liabilities	(298		)	(289		)	—			—
Net amount recognized	$	103		$	134		$	322		$	202
Amounts recognized in accumulated other comprehensive loss consist of:
Net actuarial loss	$	689		$	611		$	228		$	286
Prior service credit	(1		)	(1		)	—			—
Net amount recognized	$	688		$	610		$	228		$	286

In addition to the pension plans in the above table, we also maintain less significant defined benefit pension plans primarily in 14 other countries outside of the U.S. and the U.K. that comprise approximately 3 percent and 5 percent of our pension plan assets and obligations, respectively. These plans are reflected in "Other liabilities and deferred revenue" on our Consolidated Balance Sheets.

The following table presents information regarding total accumulated benefit obligation, PBO's and underfunded pension plans that are included in the preceding table:



	Qualified and Non-Qualified Pension Plans
	U.S. Plans				U.K. Plans
In millions	2015		2014		2015		2014
Total accumulated benefit obligation	$	2,499	$	2,539	$	1,311	$	1,402
Plans with accumulated benefit obligation in excess of plan assets
Accumulated benefit obligation	276		261		—		—
Plans with projected benefit obligation in excess of plan assets
Projected benefit obligation	311		301		—		—

Components of Net Periodic Pension Cost

The following table presents the net periodic pension cost under our plans:



	Qualified and Non-Qualified Pension Plans
	U.S. Plans									U.K. Plans
In millions	2015			2014			2013			2015			2014			2013
Service cost	$	80		$	66		$	70		$	27		$	24		$	21
Interest cost	102			105			93			56			63			57
Expected return on plan assets	(189		)	(173		)	(167		)	(91		)	(84		)	(72		)
Amortization of prior service credit	(1		)	(1		)	(1		)	—			—			—
Recognized net actuarial loss	45			31			62			34			26			24
Net periodic pension cost	$	37		$	28		$	57		$	26		$	29		$	30

Other changes in benefit obligations and plan assets recognized in other comprehensive income in 2015, 2014 and 2013 were as follows:



In millions	2015			2014			2013
Amortization of prior service credit	$	1		$	1		$	1
Recognized actuarial loss	(79		)	(57		)	(86		)
Incurred actuarial (gain) loss	105			133			(168		)
Foreign exchange translation adjustments	(7		)	(18		)	10
Total recognized in other comprehensive income	$	20		$	59		$	(243	)

Total recognized in net periodic pension cost and other comprehensive income	$	83		$	116		$	(156	)

The amount in accumulated other comprehensive loss expected to be recognized as a component of net periodic pension cost during the next fiscal year is a net actuarial loss of $44 million.

Assumptions

The table below presents various assumptions used in determining the PBO for each year and reflects weighted-average percentages for the various plans as follows:



	Qualified and Non-Qualified Pension Plans
	U.S. Plans				U.K. Plans
	2015		2014		2015		2014
Discount rate	4.47	%	4.07	%	3.95	%	3.80	%
Compensation increase rate	4.88	%	4.88	%	3.75	%	4.25	%

The table below presents various assumptions used in determining the net periodic pension cost and reflects weighted-average percentages for the various plans as follows:



	Qualified and Non-Qualified Pension Plans
	U.S. Plans						U.K. Plans
	2015		2014		2013		2015		2014		2013
Discount rate	4.07	%	4.83	%	3.97	%	3.80	%	4.60	%	4.70	%
Expected return on plan assets	7.50	%	7.50	%	8.00	%	5.80	%	5.80	%	5.80	%
Compensation increase rate	4.88	%	4.91	%	4.91	%	4.25	%	4.50	%	4.00	%

Plan Assets

Our investment policies in the U.S. and U.K. provide for the rebalancing of assets to maintain our long-term strategic asset allocation. We are committed to its long-term strategy and do not attempt to time the market given empirical evidence that asset allocation is more critical than individual asset or investment manager selection. Rebalancing of the assets has and continues to occur. The rebalancing is critical to having the proper weighting of assets to achieve the expected total portfolio returns. We believe that our portfolio is highly diversified and does not have any significant exposure to concentration risk. The plan assets for our defined benefit pension plans do not include any of our common stock.

U.S. Plan Assets

For the U.S. qualified pension plans, our assumption for the expected return on assets was 7.5 percent in 2015. Projected returns are based primarily on broad, publicly traded equity and fixed income indices and forward-looking estimates of active portfolio and investment management. We expect additional positive returns from this active investment management. Based on the historical returns and forward-looking return expectations, we have elected to continue using our assumption of 7.5 percent in 2016.

The primary investment objective is to exceed, on a net-of-fee basis, the rate of return of a policy portfolio comprised of the following:



Asset Class	Target		Range
U.S. equities	9.0	%	+/-5.0%
Non-U.S. equities	3.0	%	+/-3.0%
Global equities	6.0	%	+/-3.0%
Total equities	18.0	%
Real estate	7.0	%	+3.0/-7.0%
Private equity	7.0	%	+3.0/-7.0%
Opportunistic	4.0	%	+6.0/-4.0%
Fixed income	64.0	%	+/-5.0%
Total	100.0	%

The fixed income component is structured to represent a custom bond benchmark that will closely hedge the change in the value of our liabilities. This component is structured in such a way that its benchmark covers approximately 95 percent of the plan's exposure to changes in its discount rate (AA corporate bond yields). In order to achieve a hedge on more than the targeted 64 percent of plan assets invested in fixed income securities, our Benefits Policy Committee (BPC) permits the fixed income managers, other managers or the custodian/trustee to utilize derivative securities, as part of a liability driven investment strategy to further reduce the plan's risk of declining interest rates. However, all managers hired to manage assets for the trust are prohibited from using leverage unless specifically discussed with the BPC and approved in their guidelines.

U.K. Plan Assets

For the U.K. qualified pension plans, our assumption for the expected return on assets was 5.8 percent in 2015. The methodology used to determine the rate of return on pension plan assets in the U.K. was based on establishing an equity-risk premium over current long-term bond yields adjusted based on target asset allocations. Our strategy with respect to our investments in these assets is to be invested in a suitable mixture of return-seeking assets such as equities and real estate and liability matching assets such as bonds with a long-term outlook. Therefore, the risk and return balance of our U.K. asset portfolio should reflect a long-term horizon. To achieve these objectives we have established the following targets:



Asset Class	Target
Global equities	23.0	%
Real estate	5.0	%
Re-insurance	8.0	%
Corporate credit instruments	7.5	%
Fixed income	56.5	%
Total	100.0	%

As part of our strategy in the U.K. we have not prohibited the use of any financial instrument, including derivatives. Based on the above discussion, we have elected an assumption of 4.7 percent in 2016.

Fair Value of U.S. Plan Assets

The fair values of U.S. pension plan assets by asset category were as follows:



	Fair Value Measurements at December 31, 2015
In millions	Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)		Total
Equities
U.S.	$	96	$	—	$	—	$	96
Non-U.S.	130		—		—		130
Fixed Income
Government debt	—		533		—		533
Corporate debt
U.S.	—		406		—		406
Non-U.S.	—		80		—		80
Asset/mortgaged backed securities	—		56		—		56
Net cash equivalents⁽¹⁾	42		10		—		52
Derivative instruments⁽²⁾	—		3		—		3
Private equity and real estate⁽³⁾	—		—		203		203
Net plan assets subject to leveling	$	268	$	1,088	$	203	$	1,559
Pending trade/purchases/sales							(27		)
Accruals⁽⁴⁾							10
Investments measured at net asset value							1,094
Net plan assets							$	2,636



	Fair Value Measurements at December 31, 2014
In millions	Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)		Total
Equities
U.S.	$	103	$	—	$	—	$	103
Non-U.S.	137		—		—		137
Fixed Income
Government debt	—		579		—		579
Corporate debt
U.S.	—		346		—		346
Non-U.S.	—		71		—		71
Asset/mortgaged backed securities	—		43		—		43
Net cash equivalents⁽¹⁾	28		2		—		30
Derivative instruments⁽²⁾	—		2		—		2
Private equity and real estate ⁽³⁾	—		—		202		202
Net plan assets subject to leveling	$	268	$	1,043	$	202	$	1,513
Pending trade/purchases/sales							5
Accruals⁽⁴⁾							9
Investments measured at net asset value							1,186
Net plan assets							$	2,713

____________________________________________________


⁽¹⁾	Cash equivalents include commercial paper, short-term government/agency, mortgage and credit instruments.


⁽²⁾	Derivative instruments include interest rate swaps and credit default swaps.


⁽³⁾	The instruments in private equity and real estate funds, for which quoted market prices are not available, are valued at their estimated fair value as determined by applicable investment managers or by audited financial statement of the funds.


⁽⁴⁾	Accruals include interest or dividends that were not settled at December 31.

Certain of our assets are valued based on their respective net asset value (NAV) (or its equivalent), as an alternative to estimate fair value due to the absence of readily available market prices. The fair value of each such investment category was as follows:


•	U.S. and Non-U.S. Equities ($335 million and $379 million at December 31, 2015 and 2014) - These commingled funds have observable net asset values provided to investors and provide for liquidity either immediately or within a couple of days.


•	Government Debt ($287 million and $307 million at December 31, 2015 and 2014) - These commingled funds have observable net asset values provided to investors and provide for liquidity either immediately or within a couple of days.


•	U.S. and Non-U.S. Corporate Debt ($346 million and $394 million at December 31, 2015 and 2014) - These commingled funds have observable net asset values provided to investors and provide for liquidity either immediately or within a couple of days.


•	Real Estate ($119 million and $104 million at December 31, 2015 and 2014) - This asset type represents different types of real estate including development property, industrial property, individual mortgages, office property, property investment companies, and retail property. These funds are valued using net asset values and allow quarterly or more frequent redemptions.


•	Asset/Mortgage Backed Securities ($7 million and $2 million at December 31, 2015 and 2014) - This asset type represents investments in fixed- and floating-rate loans. These funds are valued using net asset values and allow quarterly or more frequent redemptions.

The reconciliation of Level 3 assets was as follows:



	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
In millions	Private Equity			Real Estate			Total
Balance at December 31, 2013	$	153		$	50		$	203
Actual return on plan assets
Unrealized gains on assets still held at the reporting date	22			4			26
Purchases, sales and settlements, net	(27		)	—			(27		)
Balance at December 31, 2014	148			54			202
Actual return on plan assets
Unrealized gains on assets still held at the reporting date	17			8			25
Purchases, sales and settlements, net	(22		)	(2		)	(24		)
Balance at December 31, 2015	$	143		$	60		$	203

Fair Value of U.K. Plan Assets

In July 2012, the U.K. pension plan purchased an insurance contract that will guarantee payment of specified pension liabilities. The contract defers payment for 10 years and is included in the table below in Level 3 for years ended December 31, 2015 and 2014 at a value of $445 million and $462 million, respectively.

The fair values of U.K. pension plan assets by asset category were as follows:



	Fair Value Measurements at December 31, 2015
In millions	Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)		Total
Equities
U.S.	$	—	$	250	$	—	$	250
Non-U.S.	—		269		—		269
Fixed Income
Corporate debt
Non-U.S.	—		45		—		45
Net cash equivalents⁽¹⁾	33		—		—		33
Private equity, real estate & insurance⁽²⁾	—		—		601		601
Net plan assets subject to leveling	$	33	$	564	$	601	$	1,198
Investments measured at net asset value							514
Net plan assets							$	1,712



	Fair Value Measurements at December 31, 2014
In millions	Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)		Total
Equities
U.S.	$	—	$	153	$	—	$	153
Non-U.S.	—		399		—		399
Fixed Income
Corporate debt non-U.S.	—		47		—		47
Net cash equivalents⁽¹⁾	24		—		—		24
Private equity, real estate & insurance⁽²⁾	—		—		604		604
Net plan assets subject to leveling	$	24	$	599	$	604	$	1,227
Investments measured at net asset value							497
Net plan assets							$	1,724

_____________________________________________________


⁽¹⁾	Cash equivalents include commercial paper, short-term government/agency, mortgage and credit instruments.


⁽²⁾	The instruments in private equity and real estate funds, for which quoted market prices are not available, are valued at their estimated fair value as determined by applicable investment managers or by audited financial statement of the funds.

Certain of our assets are valued based on their respective NAV (or its equivalent), as an alternative to estimate fair value due to the absence of readily available market prices. The fair value of each such investment category was as follows:


•	U.S. and Non-U.S. Corporate Debt ($458 million and $432 million at December 31, 2015 and 2014) - These commingled funds have observable net asset values provided to investors and provide for liquidity either immediately or within a couple of days.


•	Re-insurance ($56 million and $65 million at December 31, 2015 and 2014) - This commingled fund has a net asset value that is determined on a monthly basis and the investment may be sold at that value.

The reconciliation of Level 3 assets was as follows:



	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
In millions	Insurance			Real Estate			Private Equity		Total
Balance at December 31, 2013	$	440		$	69		$	48	$	557
Actual return on plan assets
Unrealized (losses) gains on assets still held at the reporting date	42			(3		)	11		50
Purchases, sales and settlements, net	(20		)	(5		)	22		(3		)
Balance at December 31, 2014	462			61			81		604
Actual return on plan assets
Unrealized gains on assets still held at the reporting date	6			7			10		23
Purchases, sales and settlements, net	(23		)	(11		)	8		(26		)
Balance at December 31, 2015	$	445		$	57		$	99	$	601

Level 3 Assets

The investments in an insurance contract, private equity and real estate funds, for which quoted market prices are not available, are valued at their estimated fair value as determined by applicable investment managers or by quarterly financial statements of the funds. These financial statements are audited at least annually. In conjunction with our investment consultant, we monitor the fair value of the insurance contract as periodically reported by our insurer and their counterparty risk. The fair value of all real estate properties, held in the partnerships, are valued at least once per year by an independent professional real estate valuation firm. Fair value generally represents the fund's proportionate share of the net assets of the investment partnerships as reported by the general partners of the underlying partnerships. Some securities with no readily available market are initially valued at cost, utilizing independent professional valuation firms as well as market comparisons with subsequent adjustments to values which reflect either the basis of meaningful third-party transactions in the private market or the fair value deemed appropriate by the general partners of the underlying investment partnerships. In such instances, consideration is also given to the financial condition and operating results of the issuer, the amount that the investment partnerships can reasonably expect to realize upon the sale of the securities and any other factors deemed relevant. The estimated fair values are subject to uncertainty and therefore may differ from the values that would have been used had a ready market for such investments existed and such differences could be material.

Estimated Future Contributions and Benefit Payments

We plan to contribute approximately $150 million to our defined benefit pension plans in 2016. The table below presents expected future benefit payments under our pension plans:



	Qualified and Non-Qualified Pension Plans
In millions	2016		2017		2018		2019		2020		2021 - 2025
Expected benefit payments	$	281	$	232	$	238	$	244	$	248	$	1,296

Other Pension Plans

We also sponsor defined contribution plans for certain hourly and salaried employees. Our contributions to these plans were $74 million, $73 million and $66 million for the years ended December 31, 2015, 2014 and 2013.