Costco 2006 Annual Report Download - page 48

Insurance/Self Insurance Liabilities
The Company uses a combination of insurance and self-insurance mechanisms, including a wholly-
owned captive insurance entity and participation in a reinsurance pool, to provide for potential liabilities
for workers’ compensation, general liability, property damage, director and officers’ liability, vehicle
liability and employee health care benefits. Liabilities associated with the risks that are retained by the
Company are not discounted and are estimated, in part, by considering historical claims experience
and evaluations of outside expertise, demographic factors, severity factors and other actuarial
assumptions. The estimated accruals for these liabilities could be significantly affected if future
occurrences and claims differ from these assumptions and historical trends. As of the end of fiscal
2006 and 2005, these liabilities of $491,037 and $453,745, respectively, were included in accrued
salaries and benefits, other current liabilities and accounts payable on the consolidated balance
sheets.
The Company’s wholly owned captive insurance subsidiary participates in a reinsurance pool. The
member agreements and practices of the reinsurance pool limit any participating members’ individual
risk. Reinsurance revenues earned of $67,589, $61,697 and $67,903 during fiscal 2006, 2005 and
2004, respectively, were primarily related to premiums received from the reinsurance pool.
Reinsurance costs of $65,760, $65,830 and $62,910 during fiscal 2006, 2005 and 2004, respectively,
were primarily related to premiums paid to the reinsurance pool. Both revenues and costs were
presented net in selling, general and administrative expenses in the consolidated statements of
income.
Derivatives
The Company has limited involvement with derivative financial instruments and uses them only to
manage well-defined interest rate and foreign exchange risks. Forward foreign exchange contracts are
used to hedge the impact of fluctuations of foreign exchange on inventory purchases and typically have
very short terms. The aggregate notional amount, which approximates the fair value of foreign
exchange contracts outstanding at September 3, 2006 and August 28, 2005, was $63,487 and
$42,466, respectively. The majority of the forward foreign exchange contracts were entered into by the
Company’s wholly-owned United Kingdom subsidiary primarily to hedge U.S. dollar merchandise
inventory purchases.
The Company also holds interest rate swaps to manage the interest rate risk associated with its
borrowings and the mix of fixed-rate and variable-rate debt. As of September 3, 2006 and August 28,
2005, the Company had “fixed-to-floating” interest rate swaps with an aggregate notional amount of
$300,000 and an aggregate fair value of $1,243 and $7,688, respectively. This amount was recorded in
deferred income taxes and other current assets as of September 3, 2006 and in other assets as of
August 28, 2005, on the Company’s consolidated balance sheets. These swaps were entered into
effective March 25, 2002, and are designated and qualify as fair value hedges of the Company’s
$300,000 5
1
⁄ 2 % Senior Notes. As the terms of the swaps match those of the underlying hedged debt,
the changes in the fair value of these swaps are offset by corresponding changes in the carrying
amount of the hedged debt and result in no net earnings impact.
The Company is exposed to market risk for changes in utility commodity pricing, which it partially
mitigates though the use of firm-price contracts with counterparties for approximately 19% of its
locations. The effects of these arrangements were not significant for any period presented.
Equity Investments in Subsidiary and Joint Ventures
During both fiscal 2006 and 2005, the Company contributed an additional $15,000 each year to its
investment in Costco Mexico (a 50%-owned joint venture), which did not impact its percentage
46