American Airlines 2005 Annual Report Download - page 44

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41
Revenue earned from selling AAdvantage miles to other companies is recognized in two components. The
first component represents the revenue for air transportation sold and is valued at fair value. This revenue
is deferred and recognized over the period the mileage is expected to be used, which is currently estimated
to be 28 months. The second revenue component, representing the marketing products sold and
administrative costs associated with operating the AAdvantage program, is recognized in the month of sale.
The number of free travel awards used for travel on American and American Eagle was 2.6 million in 2005
and 2004, representing approximately 7.2 percent and 7.5 percent of passengers boarded, respectively.
The Company believes displacement of revenue passengers is minimal given the Company’s load factors,
its ability to manage frequent flyer seat inventory, and the relatively low ratio of free award usage to total
passengers boarded.
Changes to the percentage of the amount of revenue deferred, deferred recognition period, percentage of
awards expected to be redeemed for travel on participating airlines, cost per mile estimates or the minimum
award level accrued could have a significant impact on the Company’s revenues or incremental cost
accrual in the year of the change as well as in future years.
Pensions and other postretirement benefits – The Company’s pension and other postretirement benefit
costs and liabilities are calculated using various actuarial assumptions and methodologies. The Company
uses certain assumptions including, but not limited to, the selection of the: (i) discount rate; (ii) expected
return on plan assets; and (iii) expected health care cost trend rate.
These assumptions as of December 31 were:
2005 2004
Discount rate 5.75% 6.00%
Expected return on plan assets 8.75% 9.00%
Expected health care cost trend rate:
Pre-65 individuals
Initial 4.5% 4.5%
Ultimate 4.5% 4.5%
Post-65 individuals
Initial 9.0% 10.0%
Ultimate (2010) 4.5% 4.5%
The Company’s discount rate is determined based upon the review of year-end high quality corporate bond
rates. Lowering the discount rate by 50 basis points as of December 31, 2005 would increase the
Company’s pension and postretirement benefits obligations by approximately $662 million and $170 million,
respectively, and increase estimated 2006 pension and postretirement benefits expense by $75 million and
$9 million, respectively.
The expected return on plan assets is based upon an evaluation of the Company's historical trends and
experience taking into account current and expected market conditions and the Company’s target asset
allocation of 40 percent longer duration corporate bonds, 25 percent U.S. value stocks, 20 percent
developed international stocks, five percent emerging markets stocks and bonds and ten percent
alternative (private) investments. The expected return on plan assets component of the Company’s net
periodic benefit cost is calculated based on the fair value of plan assets and the Company’s target asset
allocation. The Company monitors its actual asset allocation and believes that its long-term asset
allocation will continue to approximate its target allocation. The Company’s historical annualized ten-year
rate of return on plan assets, calculated using a geometric compounding of monthly returns, is
approximately 10.6 percent as of December 31, 2005. Lowering the expected long-term rate of return on
plan assets by 50 basis points as of December 31, 2005 would increase estimated 2006 pension expense
by approximately $38 million.