GE 2006 Annual Report Download - page 67

PENSION ASSUMPTIONS are significant inputs to the actuarial
models that measure pension benefit obligations and related
effects on operations. Two assumptions — discount rate and
expected return on assets — are important elements of plan
expense and asset/liability measurement. We evaluate these
critical assumptions at least annually on a plan and country-
specific basis. We evaluate other assumptions involving demo-
graphic factors, such as retirement age, mortality and turnover
periodically, and update them to reflect our experience and
expectations for the future. Actual results in any given year will
often differ from actuarial assumptions because of economic
and other factors.
Accumulated and projected benefit obligations are expressed
as the present value of future cash payments. We discount those
cash payments using the weighted average of market-observed
yields for high quality fixed income securities with maturities
that correspond to the payment of benefits. Lower discount rates
increase present values and subsequent-year pension expense;
higher discount rates decrease present values and subsequent-
year pension expense.
To reflect market interest rate conditions, we increased our
discount rate for principal pension plans at December 31, 2006,
from 5.50% to 5.75% and reduced the discount rate at
December 31, 2005, from 5.75% to 5.50%.
To determine the expected long-term rate of return on
pension plan assets, we consider the current and expected asset
allocations, as well as historical and expected returns on various
categories of plan assets. Assets in our principal pension plans
earned 16.7% in 2006, and had average annual earnings of 9.2%,
10.0% and 12.6% per year in the five, 10 and 25-year periods
ended December 31, 2006, respectively. We believe that these
results, in connection with our current and expected asset
allocations, support our assumed long-term return of 8.5% on
those assets.
Sensitivity to changes in key assumptions for our principal
pension plans follows.
• Discount rate — A 25 basis point increase in discount rate
would decrease pension cost in the following year by
$0.2 billion.
• Expected return on assets — A 50 basis point increase in
the expected return on assets would decrease pension cost
in the following year by $0.2 billion.
Further information on our pension plans is provided in the
Operations — Overview section and in note 7.
INCOME TAXES. Our annual tax rate is based on our income,
statutory tax rates and tax planning opportunities available to
us in the various jurisdictions in which we operate. Tax laws are
complex and subject to different interpretations by the taxpayer
and respective governmental taxing authorities. Signifi cant
judgment is required in determining our tax expense and in
evaluating our tax positions. We review our tax positions quarterly
and adjust the balances as new information becomes available.
Deferred income tax assets represent amounts available to
’   
reduce income taxes payable on taxable income in future years.
Such assets arise because of temporary differences between
the financial reporting and tax bases of assets and liabilities, as
well as from net operating loss and tax credit carryforwards.
We evaluate the recoverability of these future tax deductions by
assessing the adequacy of future expected taxable income from
all sources, including reversal of taxable temporary differences,
forecasted operating earnings and available tax planning strategies.
These sources of income inherently rely heavily on estimates.
We use our historical experience and our short and long-range
business forecasts to provide insight. Further, our global and
diversified business portfolio gives us the opportunity to employ
various prudent and feasible tax planning strategies to facilitate
the recoverability of future deductions. Amounts recorded for
deferred tax assets related to non-U.S. net operating losses, net
of valuation allowance were $2.0 billion and $1.4 billion at
December 31, 2006 and 2005, respectively. Such year-end 2006
amounts are expected to be fully recoverable within the applicable
statutory expiration periods. To the extent we believe it is more
likely than not that a deferred tax asset will not be recovered, a
valuation allowance is established.
Further information on income taxes is provided in the
Operations — Overview section and in notes 8 and 21.
DERIVATIVES AND HEDGING. We use derivatives to manage a
variety of risks, including risks related to interest rates, foreign
exchange and commodity prices. Accounting for derivatives as
hedges requires that, at inception and over the term of the
arrangement, the hedged item and related derivative meet the
requirements for hedge accounting. The rules and interpretations
related to derivatives accounting are complex. Failure to apply
this complex guidance correctly will result in all changes in the
fair value of the derivative being reported in earnings, without
regard to the offsetting changes in the fair value of the hedged
item. The accompanying financial statements reflect the conse-
quences of loss of hedge accounting for certain positions.
In evaluating whether a particular relationship qualifi es for
hedge accounting, we first determine whether the relationship
meets the strict criteria to qualify for exemption from ongoing
effectiveness testing. For a relationship that does not meet these
criteria, we test effectiveness at inception and quarterly there-
after by determining whether changes in the fair value of the
derivative offset, within a specified range, changes in the fair
value of the hedged item. This test is conducted on a cumulative
basis each reporting period. If fair value changes fail this test,
we discontinue applying hedge accounting to that relationship
prospectively. Fair values of both the derivative instrument and
the hedged item are calculated using internal valuation models
incorporating market-based assumptions, subject to third-party
confi rmation.
At December 31, 2006, derivative assets and liabilities were
$2.2 billion and $2.9 billion, respectively. Further information
about our use of derivatives is provided in notes 18, 23 and 27.
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