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MASTER GUARANTEE AGREEMENT
This MASTER GUARANTEE AGREEMENT, dated as of May 25, 2001 (this "Guarantee Agreement"), is
made by Foster Wheeler LLC, a Delaware limited liability company ("FW LLC"), Foster Wheeler International
Holdings Inc., a Delaware corporation ("FW International" and together with FW LLC, the "Guarantors") and
Foster Wheeler Ltd., a Bermuda company ("FW Ltd." or the "Supplemental Guarantor") for the benefit of the
Beneficiaries and the Officers (each as defined below). Capitalized terms used herein and not otherwise defined
shall have the definitions given such terms in the Merger Agreement (defined below).
W I T N E S S E T H:
WHEREAS, (1) pursuant to an Agreement and Plan of Merger among Foster Wheeler Corporation, a New
York corporation, ("FWC"), FW Ltd. and FW LLC, dated May 25, 2001 (the "Merger Agreement"), FWC will
merge with and into FW LLC, with FW LLC being the surviving entity, and with each outstanding share of FWC
common stock (other than those shares held by FWC or any direct or indirect subsidiary of FWC) automatically
converting into one common share of FW Ltd. and all current stockholders of FWC becoming shareholders of
FW Ltd., and (2) FWC and /or its successor will take certain actions to reorganize the internal structure of FWC
so that FWC and/or its successor may take certain actions, including the creation of new subsidiaries, the transfer
and/or sale of certain assets, liabilities and stock to the wholly-owned subsidiaries of FWC and /or its successor,
the execution of intercompany notes between the subsidiaries and/or FWC, the amendment of certain employee
benefit plans, employment agreements and stock option plans (the "Reorganization");
WHEREAS, in connection with the Reorganization, the sponsorship of those certain employee and director
benefit plans and incentive compensation plans listed in Annex 1 attached hereto (the "Plans") shall be transferred
from FWC to Foster Wheeler US Holdings, Inc., a Delaware corporation ("FW US"), including any assets,
obligations and liabilities to each participant or beneficiary of the Plans (collectively the "Beneficiaries")
thereunder;
WHEREAS, in connection with the Reorganization, FW US shall enter into certain change of control employment
agreements, substantially in the form attached as Annex 2 hereto, with each officer (collectively the "Officers")
listed in Annex 3 attached hereto (each agreement a "New Change of Control Agreement" and collectively the
"New Change of Control Agreements"), as of the Effective Time;
WHEREAS, each Guarantor will obtain benefits from the Reorganization and, accordingly, desires to execute this
Guarantee Agreement in order to guarantee FW US's obligations under the Plans and/or the New Change of
Control Agreements; and
WHEREAS, FW Ltd. will obtain benefits from the Reorganization and, accordingly, desires to execute this
Guarantee Agreement in order to guarantee the performance of the obligations of the Guarantors hereunder with
respect to the New Change of Control Agreements and to undertake certain other obligations under the New
Change of Control Agreements.
NOW, THEREFORE, in consideration of the foregoing and other benefits accruing to each Guarantor, the
receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows:
Section 1.On and after the Effective Time, the Guarantors hereby jointly, severally, irrevocably and
unconditionally guarantee FW US's performance of its obligations under the Plans, as if the Guarantors
sponsored or maintained the Plans. This guarantee shall be a continuing, absolute and unconditional guarantee and
shall remain in full force and effect until all obligations under the Plans have been performed in full by FW US or
either of the Guarantors, as the case may be.
Section 2.On and after the Effective Time, the Guarantors hereby jointly, severally, irrevocably and
unconditionally guarantee FW US's performance of its obligations under the New Change of Control
Agreements, as if the Guarantors had entered into the New Change of Control Agreements with each respective
Officer. This guarantee shall be a continuing, absolute and unconditional guarantee and shall remain in full force
and effect until all obligations under the New Change of Control Agreements have been performed in full by FW
US or either of the Guarantors, as the case may be.
Section 3.(a) On and after the Effective Time, the Supplemental Guarantor hereby irrevocably and
unconditionally guarantees the Guarantors' performance of their obligations under the New Change of Control
Agreements. This guarantee shall be a continuing, absolute and unconditional guarantee and shall remain in full
force and effect until all obligations under the New Change of Control Agreements have been performed in full by
FW US, the Guarantors or the Supplemental Guarantor, as the case may be.
(b) In addition to the guarantee in (a), the Supplemental Guarantor hereby agrees to perform and be bound by its
obligations under Section 11(d) of each New Change of Control Agreement.
Section 4. The obligations of each Guarantor and the Supplemental Guarantor under this Guarantee Agreement
are limited to the maximum amount which, after giving effect to all other contingent and fixed liabilities of such
Guarantor or Supplemental Guarantor and after giving effect to any collections from or payments made by or on
behalf of any other Guarantor in respect of the obligations of such other Guarantor under its Guarantee, will result
in the obligations of such Guarantor under the Guarantee not constituting a fraudulent conveyance or fraudulent
transfer under any applicable federal or state law.
Section 5. Each payment to be made by a Guarantor or the Supplemental Guarantor hereunder in respect of the
obligations shall be made without set-off, counterclaim, reduction or diminution of any kind or nature.
-2-
Section 6.The obligations of each Guarantor hereunder are and shall be absolute and unconditional and any
monies or amounts expressed to be owing or payable by each Guarantor hereunder which may not be
recoverable from such Guarantor on the basis of a guarantee shall be recoverable from such Guarantor as a
primary obligor and principal debtor in respect thereof.
Section 7. The obligations of each Guarantor and the Supplemental Guarantor hereunder shall be continuing and
shall remain in full force and effect until all the obligations have been paid and satisfied in full.
Section 8.THIS GUARANTEE AGREEMENT AND THE RIGHTS AND OBLIGATIONS OF THE
BENEFICIARIES, THE OFFICERS AND THE UNDERSIGNED HEREUNDER SHALL BE GOVERNED
BY AND CONSTRUED IN ACCORDANCE WITH THE LAW OF THE STATE OF NEW YORK.
Section 9.This Guarantee Agreement may be executed in any number of counterparts and by the different parties
hereto on separate counterparts, each of which counterparts when executed and delivered shall be an original,
but all of which shall together constitute one and the same instrument.
Section 10. The invalidity or unenforceability of any provision of this Guarantee Agreement shall not affect the
validity or enforceability of the remaining provisions herein.
-3-
IN WITNESS WHEREOF, FW LLC, FW Ltd. and FW International have caused this Guarantee Agreement to
be duly executed and delivered by their respective officers thereunto duly authorized, effective for all purposes as
of the date first written.
FOSTER WHEELER LLC
By: /S/ THOMAS R. O'BRIEN
---------------------
Title: Manager
FOSTER WHEELER LTD.
By: /S/ THOMAS R. O'BRIEN
---------------------
Title: President and CEO
FOSTER WHEELER International Holdings, Inc.
By: /S/ THOMAS R. O'BRIEN
---------------------
Title: Senior Vice President
-4-
ANNEX 1
LIST OF BENEFIT PLANS AND STOCK INCENTIVE PLANS
FW US Salaried Employees Pension Plan
FW US 401(k) Plan
Retirement Plan for Bargaining Unit Employees of Foster Wheeler USA Corporation and Foster Wheeler Energy
Corporation FW US Management Incentive Life Insurance Program FW US Survivor Income Plan
FW US Supplemental Employee Retirement Plan FW US Deferred Compensation Plan for Directors 1995
Stock Option Plan of FW US
1984 Stock Option Plan of FW US
Directors' Stock Option Plan of FW US
FW US Directors Deferred Compensation and Stock Award Plan FW US Executive Compensation Plan
FW US Executive Stock Ownership Plan
ANNEX 2
FORM OF
CHANGE OF CONTROL EMPLOYMENT AGREEMENT
ANNEX 3
LIST OF OFFICERS
Henry E. Bartoli
John C. Blythe
Lisa Fries Gardner
Robert D. Iseman
Thomas R. O'Brien
Gilles A. Renaud
James E. Schessler
[LOGO]
FOSTER WHEELER LTD.
May 29, 2001
NAME
ADDRESS 1
CITY STATE POSTALCODE
Dear [FirstName] :
This letter will confirm the agreement between you and Foster Wheeler Inc. (the "Company") regarding certain
terms and conditions relating to your employment by the Company.
In the event that the Company terminates your employment (as defined in Paragraph 4 Subsections (a) and (b) of
the Change of Control Employment Agreement) between the date hereof and December 31, 2003 for any
reason, other than (i) death; (ii) disability (as defined in the Company's long-term disability plan), or (iii)
conviction of, indictment for, or the entry of a guilty plea or plea of no contest with respect to a felony offense, the
Company agrees to provide you with the following separation benefits:
1. You will continue to receive your base salary in effect on the date of termination of employment for a period
(the "Salary Continuation Period") commencing on the date of termination and continuing until the greater of (i)
December 31, 2003 or (ii) two years from the date of termination. Such amounts shall be paid in accordance
with the normal payroll practices of the Company. In addition, you will receive credit for both age and service
during the Salary Continuation Period under all employee benefit plans of the Company, including the Company's
pension plan and SERP, which rely on age and/or service to determine benefit. However, all of the additional
pension benefit will be paid under the non-qualified SERP Plan.
2. You will be entitled to receive all target bonuses under the annual and long-term segments of the Company's
Incentive Compensation Plan (or any successor similar plan which may be adopted in lieu of such Incentive
Compensation Plan) for all calendar years within the Salary Continuation Period. Such bonuses shall be paid at
the same time as payments are made to the other participants in such Incentive Compensation Plan or successor
plan.
3. During the Salary Continuation Period your coverage under all health and welfare benefit plans (except
vacation and sick leave accrual) will be maintained by the Company. Such coverage will be at the same levels,
including relative employer and employee portions of the cost of coverage, as with respect to similarly situated
plan participants on the commencement of the Salary Continuation Period.
CLARENDON HOUSE, 2 CHURCH STREET
HAMILTON, HM CX, BERMUDA
MAILING ADDRESS: PERRYVILLE CORPORATE PARK, CLINTON, NJ 08809-4000
PAGE 2
4. Upon the commencement of the Salary Continuation Period, the Company will cause all transfer and other
restrictions to be removed from all shares of capital stock of the Company then registered in your name. In
addition, any stock options which you then hold to purchase shares of capital stock of the Company will be
immediately vested.
The benefits enumerated above (the "Additional Benefits") will be in addition to all other benefits afforded senior
executives of the Company upon termination of employment provided, however, that if, as a result of a
termination of your employment, you receive payments and benefits pursuant to Paragraph 6, Subsection (a), of
the Change of Control Agreement between you and the Company, dated as of May 25, 2001, as such
agreement may be amended from time to time (the "Change of Control Agreement"), you shall be entitled to no
payments or benefits pursuant to this letter agreement. In consideration of the Company agreement to make the
Additional Benefits available to you, you agree that upon your termination of employment you will execute a
waiver and release in the form attached hereto. You agree that no payments or benefits pursuant to this letter
agreement will be made or provided until ten (10) days after your execution of such waiver and release.
This Agreement is not intended to preclude the benefits payable under the Change of Control Agreement of May
25, 2001, should the events as described therein occur.
This letter agreement (a) shall be binding upon and inure to the benefit of you and the Company and our
respective successors, assigns, heirs, estates and legal representatives, including any entity with which the
Company may merge or consolidate or to which all or substantially all of its assets may be transferred; or any
affiliate of the Company or such entity following the transactions referred to in the immediately preceding
paragraph; and (b) shall be governed and construed in accordance with the laws of the State of New Jersey
without giving effect to the principles of conflicts of law.
If any provision of this letter agreement is held invalid or unenforceable by any arbiter agreed to by you and the
Company or by a court of competent jurisdiction, the other provisions hereof will remain in full force and effect.
Any provision of this letter agreement so held to be invalid or unenforceable only in part or degree will remain in
full force and effect to the extent not held invalid or unenforceable.
PAGE 3
You hereby agree that you shall not defame, disparage, or criticize any employee or director of the Company, or
its affiliates or their respective products or services in any medium to any person or entity.
The management and the Board of Directors of Foster Wheeler Ltd. shall use reasonable best efforts to cause
the Company's officers and directors not to defame, disparage or criticize you. Nothing herein shall limit any
confidential discussions any of the Company's officers or directors may have with the Company's attorneys or
limit any truthful statements made by you or the Company's officers or directors in any legal proceeding or as
required by law.
If the foregoing correctly sets forth your understanding of the agreement between you and the Company with
respect to the subject matter hereof, kindly execute the enclosed copy of this letter and return it to the
undersigned in which event it shall constitute a binding agreement between you and the Company.
Very truly yours,
Richard J. Swift
Attachment
/js
Agreed to and Accepted:
{Name}
{Date}
EXHIBIT 12-1
FOSTER WHEELER LTD.
STATEMENT OF COMPUTATION OF CONSOLIDATED RATIO OF
EARNINGS TO FIXED CHARGES AND COMBINED FIXED CHARGES
($000'S)
UNAUDITED
6 months
2001
EARNINGS:
Net earnings $ 8,894
Taxes on income 7,184
Total fixed charges 46,736
Capitalized interest (315)
Capitalized interest amortized 1,211
Equity earnings of non-consolidated associated companies accounted for
by the equity method, net of dividends (85)
--------
$ 63,625
FIXED CHARGES:
Interest expense (includes dividend on preferred security of $7,875) $ 40,137
Capitalized interest 315
Imputed Interest on non-capitalized lease payment 6,284
--------
$ 46,736
Ratio of Earnings to Fixed Charges 1.36
========
Note: There were no preferred shares outstanding during the period indicated and, therefore, the consolidated
ratio of earnings to fixed charges and combined fixed charges and preferred share dividend requirements would
have been the same as the consolidated ratio of earnings to fixed charges and combined fixed charges for the
period indicated.
This calculation does not pertain to the fixed charge coverage ratio required by the amended and restated
Revolving Credit Agreement covenants.
[LOGO]
FOSTER WHEELER LTD.
August 13, 2001
Mr. Lynn E. Turner
Chief Accountant
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Mail Stop 11-3
Washington, D.C. 20549
Dear Mr. Turner:
We are writing to you to highlight an accounting change that we made in the second quarter 2001 as disclosed in
our 10-Q filed today. This matter has been discussed with our independent auditors, PricewaterhouseCoopers
LLP (PwC) who are addressing the preferability of this change. They believe that the arguments are persuasive
for this change to be considered preferable in our specific and unique circumstances; nevertheless, because of its
unusual nature, they have advised us to seek your concurrence.
BACKGROUND
From the adoption of Statement of Financial Accounting Standards (SFAS) No. 87, EMPLOYER'S
ACCOUNTING FOR PENSIONS, in 1986 through the current date, we have used the fair value of plan assets
as of the beginning of the plan year to determine the market-related value of plan assets, which is used in
estimating the expected return on asset and gain/loss amortization components of net periodic pension expense.
Fair value was originally selected after consultation with our actuaries, Milliman USA. Given the mix of
investments that comprised plan assets at that time and for the foreseeable future, we concluded that it would
result in a reasonable representation over time of the impact on net periodic pension expense and the pension
obligation resulting from the effects of changes in certain economic factors on the value of plan assets and the
pension obligation.
In accordance with the pension trustees' investment strategy, until the end of 1999 the portfolio mix of
investments was more heavily weighted in debt securities, with approximately 65% of the portfolio invested in
debt and 35% in equities. At the end of 1999 the investment committee of the pension trust amended this ratio, to
invest for the foreseeable future 70% in equities and the remainder in debt, a ratio more in concert with a majority
of other pension plans.
CLARENDON HOUSE, 2 CHURCH STREET
HAMILTON, HM CX, BERMUDA
MAILING ADDRESS: PERRYVILLE CORPORATE PARK, CLINTON, NJ 08809-4000
As a result of this significant change in investment mix, Milliman USA recently recommended that we change our
method of determining the market-related value of plan assets from fair value to a calculated value. A calculated
value is permitted under SFAS 87, including different methods of determining it. Accordingly, we considered
alternative methods of determining a calculated value that would recognize changes in fair value in a systematic
and rational manner and thus better reflect the long-term nature of the investments, including the volatility
associated with equity markets in which the plan is now predominantly invested in. We selected a calculated value
that is consistent with the method shown in Illustration 4 of SFAS 87. Under that method, the beginning of year
market related value of plan assets is increased by the expected return on plan assets and contributions, and
decreased for benefit payments. The difference between the expected and actual return on plan assets is reflected
in market related value over a period that is limited by SFAS 87 to five years. We have concluded that the
appropriate period for our purposes should be three years.
DISCUSSION
SFAS 87, paragraph 30, permits the use of a "market related value of plan assets
[which] shall be either fair value or a calculated value that recognizes changes in fair value in a systematic and
rational manner over not more than five years." Actuarial experts have informed us that approximately 75% of
companies use some form of calculated value in determining the market related values of their plan assets.
Paragraph 30 of SFAS 87 also states "...different ways of calculating market related value may be used for
different classes of assets (for example, an employer might use fair value for bonds and a five year moving
average for equities...)". This example indicates to us that the FASB expected that different market related values
might be used in practice for equities versus debt.
In our case, fair values were used during a period when plan assets were comprised principally of bonds rather
than equities. Given that investment mix, fair value was considered more appropriate because it resulted in a
consistent offsetting from period to period of the effects of changes in interest rates on both the fair value of debt
(i.e., bonds) and the value of the pension obligation (through changes in the discount rate). This offsetting is
recognized in paragraph 120 of SFAS 87 which notes that some changes in the fair value of investments are
related to certain changes in the measurement of the pension liability because they are affected by the same
economic factors. That paragraph goes on to cite as an example changes in the level of interest rates, which
would be expected to affect both the value of bonds and the discounted value of pension liabilities and notes that
those effects tend to offset each other, thus producing a more stable pension cost from period to period. With
bonds now comprising only 30% of plan assets, the offset of those fluctuations has been largely eliminated.
Accordingly, a change in the determination of market related value is appropriate to maintain an effect similar to
the offsetting that occurred when the plan assets were comprised mainly of debt. It also would be consistent with
the Board's objective of reducing unacceptable volatility (paragraph 121 of SFAS 87), which the plan is now
exposed to given the predominance of equities in its investment mix.
CONCLUSION
For these reasons we believe that under our specific circumstances a change to a calculated value that recognizes
changes in fair value systematically and rationally over a three-year period is preferable to our current method of
determining market related value. As disclosed in the attached Form 10-Q, the impact has been reflected as a
cumulative effect adjustment of $1.2 million after tax. We would appreciate the staff's concurrence with our
conclusion that this change is preferable in our circumstances.
Thank you for your attention to this matter. If you have any questions, please contact me at 908-713-2830 so
that we can arrange a conference call involving PwC.
Sincerely,
Robin Kornmeyer
Controller
cc. Jackson Day, SEC Andrew Spellman, PwC Ray Dever, PwC Ken Dakdduk, PwC
and the Company. Very truly yours, Richard J. Swift Attachment /js Agreed to and Accepted: {Name}
PAGE 3 You hereby agree that you shall not defame, disparage, or criticize any employee or director of the Company, or its affiliates or their respective products or services in any medium to any person or entity. The management and the Board of Directors of Foster Wheeler Ltd. shall use reasonable best efforts to cause the Company's officers and directors not to defame, disparage or criticize you. Nothing herein shall limit any confidential discussions any of the Company's officers or directors may have with the Company's attorneys or limit any truthful statements made by you or the Company's officers or directors in any legal proceeding or as required by law. If the foregoing correctly sets forth your understanding of the agreement between you and the Company with respect to the subject matter hereof, kindly execute the enclosed copy of this letter and return it to the undersigned in which event it shall constitute a binding agreement between you and the Company. Very truly yours, Richard J. Swift Attachment /js Agreed to and Accepted: {Name} {Date}
EXHIBIT 12-1 FOSTER WHEELER LTD. STATEMENT OF COMPUTATION OF CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES AND COMBINED FIXED CHARGES ($000'S) UNAUDITED
6 months 2001 EARNINGS: Net earnings Taxes on income Total fixed charges Capitalized interest Capitalized interest amortized Equity earnings of non-consolidated associated companies accounted for by the equity method, net of dividends $ 8,894 7,184 46,736 (315) 1,211
(85) -------$ 63,625
FIXED CHARGES: Interest expense (includes dividend on preferred security of $7,875) Capitalized interest Imputed Interest on non-capitalized lease payment $ 40,137 315 6,284 -------$ 46,736 Ratio of Earnings to Fixed Charges 1.36 ========
EXHIBIT 12-1 FOSTER WHEELER LTD. STATEMENT OF COMPUTATION OF CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES AND COMBINED FIXED CHARGES ($000'S) UNAUDITED
6 months 2001 EARNINGS: Net earnings Taxes on income Total fixed charges Capitalized interest Capitalized interest amortized Equity earnings of non-consolidated associated companies accounted for by the equity method, net of dividends $ 8,894 7,184 46,736 (315) 1,211
(85) -------$ 63,625
FIXED CHARGES: Interest expense (includes dividend on preferred security of $7,875) Capitalized interest Imputed Interest on non-capitalized lease payment $ 40,137 315 6,284 -------$ 46,736 Ratio of Earnings to Fixed Charges 1.36 ========
Note: There were no preferred shares outstanding during the period indicated and, therefore, the consolidated ratio of earnings to fixed charges and combined fixed charges and preferred share dividend requirements would have been the same as the consolidated ratio of earnings to fixed charges and combined fixed charges for the period indicated. This calculation does not pertain to the fixed charge coverage ratio required by the amended and restated Revolving Credit Agreement covenants.
[LOGO] FOSTER WHEELER LTD. August 13, 2001 Mr. Lynn E. Turner Chief Accountant U.S. Securities and Exchange Commission 450 Fifth Street, N.W. Mail Stop 11-3 Washington, D.C. 20549 Dear Mr. Turner: We are writing to you to highlight an accounting change that we made in the second quarter 2001 as disclosed in
[LOGO] FOSTER WHEELER LTD. August 13, 2001 Mr. Lynn E. Turner Chief Accountant U.S. Securities and Exchange Commission 450 Fifth Street, N.W. Mail Stop 11-3 Washington, D.C. 20549 Dear Mr. Turner: We are writing to you to highlight an accounting change that we made in the second quarter 2001 as disclosed in our 10-Q filed today. This matter has been discussed with our independent auditors, PricewaterhouseCoopers LLP (PwC) who are addressing the preferability of this change. They believe that the arguments are persuasive for this change to be considered preferable in our specific and unique circumstances; nevertheless, because of its unusual nature, they have advised us to seek your concurrence. BACKGROUND From the adoption of Statement of Financial Accounting Standards (SFAS) No. 87, EMPLOYER'S ACCOUNTING FOR PENSIONS, in 1986 through the current date, we have used the fair value of plan assets as of the beginning of the plan year to determine the market-related value of plan assets, which is used in estimating the expected return on asset and gain/loss amortization components of net periodic pension expense. Fair value was originally selected after consultation with our actuaries, Milliman USA. Given the mix of investments that comprised plan assets at that time and for the foreseeable future, we concluded that it would result in a reasonable representation over time of the impact on net periodic pension expense and the pension obligation resulting from the effects of changes in certain economic factors on the value of plan assets and the pension obligation. In accordance with the pension trustees' investment strategy, until the end of 1999 the portfolio mix of investments was more heavily weighted in debt securities, with approximately 65% of the portfolio invested in debt and 35% in equities. At the end of 1999 the investment committee of the pension trust amended this ratio, to invest for the foreseeable future 70% in equities and the remainder in debt, a ratio more in concert with a majority of other pension plans. CLARENDON HOUSE, 2 CHURCH STREET HAMILTON, HM CX, BERMUDA MAILING ADDRESS: PERRYVILLE CORPORATE PARK, CLINTON, NJ 08809-4000
As a result of this significant change in investment mix, Milliman USA recently recommended that we change our method of determining the market-related value of plan assets from fair value to a calculated value. A calculated value is permitted under SFAS 87, including different methods of determining it. Accordingly, we considered alternative methods of determining a calculated value that would recognize changes in fair value in a systematic and rational manner and thus better reflect the long-term nature of the investments, including the volatility associated with equity markets in which the plan is now predominantly invested in. We selected a calculated value that is consistent with the method shown in Illustration 4 of SFAS 87. Under that method, the beginning of year market related value of plan assets is increased by the expected return on plan assets and contributions, and decreased for benefit payments. The difference between the expected and actual return on plan assets is reflected in market related value over a period that is limited by SFAS 87 to five years. We have concluded that the appropriate period for our purposes should be three years. DISCUSSION
As a result of this significant change in investment mix, Milliman USA recently recommended that we change our method of determining the market-related value of plan assets from fair value to a calculated value. A calculated value is permitted under SFAS 87, including different methods of determining it. Accordingly, we considered alternative methods of determining a calculated value that would recognize changes in fair value in a systematic and rational manner and thus better reflect the long-term nature of the investments, including the volatility associated with equity markets in which the plan is now predominantly invested in. We selected a calculated value that is consistent with the method shown in Illustration 4 of SFAS 87. Under that method, the beginning of year market related value of plan assets is increased by the expected return on plan assets and contributions, and decreased for benefit payments. The difference between the expected and actual return on plan assets is reflected in market related value over a period that is limited by SFAS 87 to five years. We have concluded that the appropriate period for our purposes should be three years. DISCUSSION SFAS 87, paragraph 30, permits the use of a "market related value of plan assets [which] shall be either fair value or a calculated value that recognizes changes in fair value in a systematic and rational manner over not more than five years." Actuarial experts have informed us that approximately 75% of companies use some form of calculated value in determining the market related values of their plan assets. Paragraph 30 of SFAS 87 also states "...different ways of calculating market related value may be used for different classes of assets (for example, an employer might use fair value for bonds and a five year moving average for equities...)". This example indicates to us that the FASB expected that different market related values might be used in practice for equities versus debt. In our case, fair values were used during a period when plan assets were comprised principally of bonds rather than equities. Given that investment mix, fair value was considered more appropriate because it resulted in a consistent offsetting from period to period of the effects of changes in interest rates on both the fair value of debt (i.e., bonds) and the value of the pension obligation (through changes in the discount rate). This offsetting is recognized in paragraph 120 of SFAS 87 which notes that some changes in the fair value of investments are related to certain changes in the measurement of the pension liability because they are affected by the same economic factors. That paragraph goes on to cite as an example changes in the level of interest rates, which would be expected to affect both the value of bonds and the discounted value of pension liabilities and notes that those effects tend to offset each other, thus producing a more stable pension cost from period to period. With bonds now comprising only 30% of plan assets, the offset of those fluctuations has been largely eliminated. Accordingly, a change in the determination of market related value is appropriate to maintain an effect similar to the offsetting that occurred when the plan assets were comprised mainly of debt. It also would be consistent with the Board's objective of reducing unacceptable volatility (paragraph 121 of SFAS 87), which the plan is now exposed to given the predominance of equities in its investment mix.
CONCLUSION For these reasons we believe that under our specific circumstances a change to a calculated value that recognizes changes in fair value systematically and rationally over a three-year period is preferable to our current method of determining market related value. As disclosed in the attached Form 10-Q, the impact has been reflected as a cumulative effect adjustment of $1.2 million after tax. We would appreciate the staff's concurrence with our conclusion that this change is preferable in our circumstances. Thank you for your attention to this matter. If you have any questions, please contact me at 908-713-2830 so that we can arrange a conference call involving PwC. Sincerely, Robin Kornmeyer Controller cc. Jackson Day, SEC Andrew Spellman, PwC Ray Dever, PwC Ken Dakdduk, PwC
CONCLUSION For these reasons we believe that under our specific circumstances a change to a calculated value that recognizes changes in fair value systematically and rationally over a three-year period is preferable to our current method of determining market related value. As disclosed in the attached Form 10-Q, the impact has been reflected as a cumulative effect adjustment of $1.2 million after tax. We would appreciate the staff's concurrence with our conclusion that this change is preferable in our circumstances. Thank you for your attention to this matter. If you have any questions, please contact me at 908-713-2830 so that we can arrange a conference call involving PwC. Sincerely, Robin Kornmeyer Controller cc. Jackson Day, SEC Andrew Spellman, PwC Ray Dever, PwC Ken Dakdduk, PwC
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