Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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The following discussion should be read together with the consolidated financial statements and the notes thereto included elsewhere in this Form 10-K. This discussion contains forward-looking statements that are based on management’s current expectations, estimates and projections about our business, operations and financial performance. The cautionary statements made in this Form 10-K should be read as applying to all related forward-looking statements whenever they appear in this Form 10-K. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of a number of factors, including those we discuss under “Forward-Looking Statements,” Item 1A—Risk Factors and elsewhere in this Form 10-K.

Executive Overview

American Water is the largest and most geographically diverse investor-owned publicly-traded water and wastewater utility company in the United States, as measured both by operating revenues and population served. We employ approximately 6,700 professionals who provide drinking water, wastewater and other related services to an estimated 15 million people in 47 states, the District of Columbia and Ontario, Canada. Our primary business involves the ownership of utilities that provide water and wastewater services to residential, commercial, industrial, public and other customers. Our Regulated Businesses that provide these services are generally subject to economic regulation by state regulatory agencies in the states in which they operate. The federal government and the states also regulate environmental, health and safety and water quality matters. Our Regulated Businesses provide services in 16 states and serve approximately 3.3 million customers based on the number of active service connections to our water and wastewater networks. We also operate several businesses that provide a broad range of related and complementary water and wastewater services in non-regulated markets, which includes four operating segments that individually do not meet the criteria of a reportable segment in accordance with GAAP. These four non-reportable operating segments are collectively presented as our Market-Based Businesses, which is consistent with how management assesses the results of these businesses.

2015 Strategic Focus & Achievements

For 2015, our focus was anchored on five central strategic themes:

·Customers – Our customers are at the center of everything we do.
·In 2015, we achieved customer satisfaction ratings of 91% and service quality ratings of 85%. In addition, we continued to make needed infrastructure investment while implementing operational efficiency improvements to keep customer rates affordable.
·Safety – The health and safety of our employees, customers and the public is both a strategy and a value.
·In 2015, we continued to move our safety culture forward. We implemented a “near miss” reporting program designed for accident prevention and risk education. In addition, our vendors joined us in numerous safety fairs demonstrating options available for protective equipment used across our business.
·People – Our employees and culture are paramount to our success.
·In 2015, we demonstrated our commitment to employees by providing safety and technical training throughout our organization. We also provided business leadership training to virtually all of our front line supervisors across the company.
·Growth – We invested $1.4 billion in 2015; a record level of annual investment, including:
·$1.2 billion to improve infrastructure in our Regulated Businesses;
·$64 million for regulated acquisitions, adding approximately 24,000 water and wastewater customers; and
·$133 million for the Keystone acquisition.
·Technology and Operational Efficiency – We drove continued cost savings in our regulated businesses.
·We achieved an adjusted O&M efficiency ratio (a non-GAAP measure) of 35.9% in 2015.

2015 Financial Results

For the year ended December 31, 2015, we grew income from continuing operations more than 10%, while making capital investment in our infrastructure and implementing operational efficiency improvements to keep customer rates affordable.

201520142013
Income from continuing operations$2.64$2.39$2.07
Loss from discontinued operations, net of tax$—$(0.04)$(0.01)
Diluted earnings per share$2.64$2.35$2.06

Income from continuing operations increased 25 cents per diluted share for year ended December 31, 2015 compared to the prior year. Excluding the 2014 costs related to the Freedom Industries chemical spill in West Virginia of 4 cents per diluted share, income from continuing operations increased 21 cents per diluted share, or about 8.8%. The increase was mainly due to continued growth in both our Regulated Businesses segment and Market-Based Businesses.

Discontinued operations represents the 2014 sale of our Terratec line of business, which was part of our Market-Based Businesses. The loss from discontinued operations, net of tax, reflected in the 2014 financial results includes the loss on the sale, an income tax valuation allowance and the 2014 operating results of the entity prior to the sale.

See “Comparison of Consolidated Results of Operations” and “Segment Results” below for further detailed discussion of the consolidated results of operations, as well as our business segments. All financial information in this Management’s Discussion and Analysis of Financial Condition and Results of Operations reflects continuing operations, unless otherwise noted. See Note 3—Acquisitions and Divestitures in the Notes to Consolidated Financial Statements for further details on our discontinued operations.

Regulatory Matters

The table below provides rate authorizations effective from 2013 through 2015. The table depicts annualized incremental revenues assuming a constant water sales volume:

For the Years Ended December 31,
201520142013
(In millions)
General rate cases by state
Pennsylvania (a)$—$—$26
New Jersey (b)22——
Kentucky (c)——7
Indiana (d)5——
California (e)523
West Virginia (f)——9
Iowa (g)—4—
Other1——
Total General rate cases$33$6$45
(a)On December 19, 2013, a rate case settlement was approved with an effective date of January 1, 2014.
(b)Final order was received on September 11, 2015 with new rates effective September 21, 2015.
(c)Final order was received on October 25, 2013 with rates effective July 27, 2013.
(d)Final order issued on January 28, 2015 with new rates effective January 29, 2015.
(e)Final order for test year 2015 issued April 9, 2015 with rates effective to January 1, 2015. The 2014 and 2013 increases are from step rate and attrition year filings with rates effective on April 1, 2014 and April 1, 2013, respectively.
(f)Final order issued on September 26, 2013 by the West Virginia Public Service Commission. New rates were put into effect October 11, 2013.
(g)Effective date of new rates was April 18, 2014. The increase included approximately $3 million of interim rates that were effective May 10, 2013.

On April 30, 2015, our West Virginia subsidiary filed a general rate case requesting $36 million in additional annualized water and wastewater revenues. On July 31, 2015, our Missouri subsidiary filed a general rate case requesting $25 million in additional annualized revenue. Lastly, on October 30, 2015 our Virginia subsidiary filed a general rate case requesting $9 of additional annualized revenue.

In July 2015, Cal Am filed an application with the CPUC to request changes to the present rate design and the emergency conservation and rationing plan for water customers in certain areas within its Monterey County service district. If approved, the proposed changes would allow: (i) recovery of existing under-collections of the net water revenue adjustment mechanism/modified cost balancing account (“WRAM/MCBA”) balance, amounting to approximately $51 million as of December 31, 2015, over 20 years earning a pretax rate of 8.41%; (ii) an annual consumption true-up mechanism and rate design that provide for more timely collection of the cost of service; and (iii) modification of existing conservation and rationing plans. On November 4, 2015, Cal Am received an Assigned Commissioner’s Scoping Memo and Ruling (“Memo”) related to our WRAM filing. The Memo called for the suspension of the WRAM surcharges related to 2013 and 2014 under-collections and required Cal Am to retain an independent accounting firm to verify the actual customer water usage and billed revenue for the Monterey County service district for years ended December 31, 2013 and 2014. The results of the auditors verification was filed with the CPUC in January 2016. On February 1, 2016, Cal Am filed a motion with the CPUC to restart the surcharge collections for 2013 and 2014.

On February 16, 2016, the Commission’s Office of Ratepayer Advocates (“ORA”) issued a report on Cal Am’s requests to address Monterey rate design and the historical WRAM balances. The ORA recommends a disallowance of $17 million of the Monterey WRAM balance and also recommends that the amortization occur over five years with no interest. Additionally, the ORA recommends the CPUC deny Cal Am's request for annual consumption true up pilot program. We are in the process of reviewing the ORA proposal and will submit our response on March 4, 2016; however, we do not believe that the ORA proposals have merit. We expect a CPUC decision in mid to late 2016.

On December 30, 2015, our Indiana subsidiary filed a rate case true-up for additional annualized revenues in the amount of $2 million which were authorized and effective on January 29, 2016. On January 21, 2016, our Illinois subsidiary filed a general rate case requesting an additional $40 million in annualized revenues. On January 29, 2016, our Kentucky subsidiary filed a general rate case requesting an additional $14 million in annualized water revenues. On February 1, 2016, Cal Am received approval from the CPUC to extend its cost of capital proceeding for an additional year. As such Cal Am’s current cost of capital will remain in place through 2017.

A number of states have authorized the use of regulatory mechanisms that permit rates to be adjusted outside of a general rate case for certain costs and investments, such as infrastructure surcharge mechanisms that permit recovery of capital investments to

replace aging infrastructure. The following table details additional annualized revenues authorized through infrastructure surcharge mechanisms that were effective from 2013 through 2015:

For the Years Ended December 31,
201520142013
(In millions)
Infrastructure charges by state
Pennsylvania (a)$14$—$20
New Jersey (b)9174
Missouri (c)2138
Indiana (d)——4
Illinois (e)62—
New York (f)12—
Tennessee (g)21—
Total Infrastructure charges$34$35$36
(a)Quarterly filings made with PUC in 2015 for $8 million, $4 million and $2 million effective October 1, 2015, July 1, 2015 and April 1, 2015, respectively. No infrastructure charges in 2014 as a result of general rate case effective January 1, 2014 utilized forecasted test year and therefore qualifying infrastructure improvements already reflected in rates. For 2013, $7 million, $4 million, $3 million and $6 million effective October 1, 2013, July 1, 2013, April 1, 2013 and January 1, 2013, respectively.
(b)Semi-annual filings made with the PUC. For 2015, $9 million effective January 1, 2015. For 2014, $7 million and $10 million effective July 1, 2014 and January 1, 2014, respectively. For 2013, $4 million effective July 1, 2013.
(c)For 2015, $2 million effective June 27, 2015. For 2014, $9 million and $4 million effective December 31, 2014 and May 30, 2014, respectively. For 2013, $5 million and $3 million effective June 21, 2013 and December 14, 2013, respectively.
(d)Effective December 18, 2013.
(e)For 2015, $1 million and $5 million effective February 1, 2015 and January 1, 2015, respectively. For 2014, $2 million effective January 1, 2014.
(f)For 2015, $1 million effective December 1, 2015. For 2014, $1 million effective January 1, 2014 and March 3, 2014.
(g)For 2015, $2 million effective June 29, 2015. For 2014, $1 million effective April 15, 2014.

On December 15, 2015, our Pennsylvania subsidiary filed for additional annualized revenues from infrastructure charges in the amount of $11 million which were authorized and effective on January 1, 2016. On December 18, 2015, our Illinois subsidiary filed for additional annualized revenues from infrastructure charges in the amount of $1 million, which were authorized and also effective on January 1, 2016. On January 14, 2016, our Indiana subsidiary filed for additional annualized revenues from infrastructure charges in the amount of $3 million.

As of February 24, 2016, we are awaiting final general rate case orders in five states, requesting additional annualized revenue of $123 million. We are also awaiting approval of $5 million in additional annualized revenues for infrastructure charges. There is no assurance that all or any portion of these requests will be granted.

Technology and Operational Efficiency – Continuing Improvement in O&M Efficiency Ratio for our Regulated Businesses

We continued to improve on our O&M efficiency ratio. Our adjusted O&M efficiency ratio for the year ended December 31, 2015 was 35.9%, compared to 36.7% for the year ended December 31, 2014. The improvement in the 2015 O&M efficiency ratio over this period was attributable to both an increase in revenue and decreases in O&M expenses.

We evaluate our operating performance using this measure because management believes it is a direct measure of the efficiency of our Regulated Businesses’ operations. This information is intended to enhance an investor’s overall understanding of our operating performance. The O&M efficiency ratio is not a GAAP financial measure and may not be comparable to other companies’ operating measures and should not be used in place of the GAAP information provided elsewhere in this report.

Our O&M efficiency ratio is defined as our regulated O&M expenses divided by regulated operating revenues, where both O&M expenses and operating revenues were adjusted to eliminate purchased water expense. Additionally, from the O&M expenses, we excluded the allocable portion of non-O&M support services cost, mainly depreciation and general taxes that are reflected in the Regulated Businesses segment as O&M expenses but for consolidated financial reporting purposes are categorized within other line items in the accompanying Consolidated Statements of Operations. In addition, to the standard adjustments to the O&M efficiency ratio for the years ended December 31, 2014 and 2013, we have also excluded from operating revenues and O&M expenses the estimated impact from changes in consumption as a result of weather and the Freedom Industries chemical spill in West Virginia, as applicable. We excluded all the above items from the calculation as we believe such items are not reflective of management’s ability to increase efficiency of the Company’s regulated operations.

The following table provides the calculation and reconciliation that compares O&M expenses and operating revenues, as determined in accordance with GAAP, and to those amounts utilized in the calculation of our adjusted O&M efficiency ratio for the years ended December 31:

201520142013
(In millions)
Total operation and maintenance expenses$1,404$1,350$1,289
Less:
Operation and maintenance expenses—Market-Based Businesses358289241
Operation and maintenance expenses—Other(49)(51)(57)
Total regulated operation and maintenance expenses1,0951,1121,105
Less:
Regulated purchased water expenses117122111
Allocation of non-operation and maintenance expenses353935
Impact of Freedom Industries chemical spill in West Virginia—10—
Estimated impact of weather (mid-point of range)—(2)(2)
Adjusted regulated operation and maintenance expenses (a)$943$943$961
Total operating revenues$3,159$3,011$2,879
Less:
Operating revenues—Market-Based Businesses434355303
Operating revenues—Other(18)(18)(18)
Total regulated operating revenues2,7432,6742,594
Less:
Regulated purchased water revenues*117122111
Add:
Impact of Freedom Industries chemical spill in West Virginia—1—
Estimated impact of weather (mid-point of range)—1715
Adjusted regulated operating revenues (b)$2,626$2,570$2,498
Adjusted O&M efficiency ratio (a)/(b)35.9%36.7%38.5%
  • Note calculation assumes purchased water revenues approximate purchased water expenses.

2016 and Beyond

Our future results continue to be anchored on the five central themes noted for 2015 with customers at the center of all we do. These five central themes are:

·Customers. Our focus continues to concentrate on our customers by achieving customer satisfaction and service quality targets. In addition, we will continue to make needed infrastructure investment while implementing operational efficiency improvements to strive to keep customer rates affordable.
·Safety. Our focus continues on driving safety in everything that we do. Our safety focus includes safety and health of our employees, customers and the public.
·People. Our focus on our employees and culture is paramount to our success going forward. We intend to also focus on ensuring we have strong relationships with our union represented employees, effective training and development and diversity of our workforce.
·Growth. We expect to invest $6.4 billion over the next five years, with $1.3 billion in 2016, as follows:
·Capital investment to improve infrastructure in our Regulated Businesses segment of $5.5 billion, with $1.2 billion expected in 2016;
·Growth from acquisitions in our Regulated Businesses segment of $600 million to expand our water and wastewater customer base; and
·Growth in our Market-Based Businesses from new core growth, expanded markets and new offerings, and evaluate potential opportunities to assist the natural gas exploration and production industry in the delivery of water to support their processes. We have estimated strategic capital investments of $280 million.

The chart below presents our estimated percentage of projected capital expenditures over the period of 2016 to 2020 for improving infrastructure in our Regulated Businesses segment by purpose:

·Technology & Operational Efficiency. Continued commitment to operational efficiency, technology, innovation and environmental leadership. We intend to continue to modernize our infrastructure and focus on operational efficiencies, while bolstering a culture of continuous improvement. We have set a goal to achieve an adjusted O&M efficiency ratio equal to or below 34% by 2020. We are committed to environmental leadership while providing safe, reliable and cost-effective water and water related services to our customers.

Consolidated Results of Operations

The following table presents our consolidated results of operations for the years ended December 31:

Years Ended December 31,Increase (Decrease)Increase (Decrease)
2015201420132015 vs. 20142014 vs. 2013
(In millions)%%
Operating revenues$3,159$3,011$2,879$1484.9$1324.6
Operating expenses:
Operation and maintenance1,4041,3501,289544.0614.7
Depreciation and amortization440424407163.8174.2
General taxes24323623473.020.9
(Gain) loss on asset dispositions and purchases(3)(2)1(1)50.0(3)(300.0)
Total operating expenses, net2,0842,0081,931763.8774.0
Operating income1,0751,003948727.2555.8
Other income (expenses):
Interest, net(308)(299)(308)(9)3.09(2.9)
Loss on extinguishment of debt——(41)——41(100.0)
Other, net15699150.0(3)(33.3)
Total other income (expenses)(293)(293)(340)——47(13.8)
Income from continuing operations before income taxes7827106087210.110216.8
Provision for income taxes306280237269.34318.1
Income from continuing operations4764303714610.75915.9
Loss from discontinued operations, net of tax—(7)(2)7(100.0)(5)250.0
Net income attributable to common stockholders$476$423$369$5312.5$5414.6

Comparison of Consolidated Results of Operations

Operating revenues. In 2015, operating revenues increased $148 million, or 4.9%, primarily due to a:

·$69 million increase in our Regulated Businesses segment primarily due to rate increases, infrastructure charges and increased demand, partially offset by decreased surcharges and balancing accounts in 2015;
·$53 million increase in our Market-Based Businesses primarily due to incremental revenue from increased construction project activity in our Military Services Group and contract growth in our Homeowners Services Group; and
·$26 million increase attributable to our Keystone acquisition, which is included in our Market-Based Businesses.

In 2014, consolidated operating revenues increased $132 million, or 4.6%, primarily due to an:

·$80 million increase in our Regulated Businesses segment primarily due to rate increases, incremental revenues from surcharges and balancing accounts and acquisitions, partially offset by reduced consumption in 2014; and
·$52 million increase in our Market-Based Businesses primarily due to incremental revenue from increased construction project activity in our Military Services Group and organic growth in our Homeowner Services Group.

Operation and maintenance. In 2015, operation and maintenance expense increased $54 million, or 4.0%, primarily due to a:

·$45 million increase in our Market-Based Businesses primarily due to incremental costs in our Military Services Group and Homeowner Services Group corresponding with the increases in operating revenues discussed above;
·$24 million increase attributable to our Keystone acquisition; partially offset by a
·$17 million decrease in our Regulated Businesses segment primarily due to lower production costs, contract services and transportation costs, partially offset by higher casualty insurance costs.

In 2014, operation and maintenance expense increased $61 million, or 4.7%, primarily due to a:

·$49 million increase in our Market-Based Businesses primarily due to incremental costs in our Military Services Group and Homeowner Services Group corresponding with the increases in operating revenues discussed above; and
·$6 million increase in our Regulated Businesses segment primarily due to increased production costs, uncollectible expense, maintenance expenses and costs associated with the Freedom Industries chemical spill in West Virginia partially offset by lower employee-related costs.

Depreciation and amortization. In 2015 and 2014, depreciation and amortization expense increased $16 million and $17 million, or 3.8% and 4.2%, respectively. The increase for both periods was primarily due to additional utility plant placed in service.

Other income (expenses). In 2014, other expenses decreased by $47 million, or 13.8%, primarily due to the recognition of a pre-tax loss on debt extinguishment in 2013 of $41 million in connection with the cash tender offer for our 6.085% Senior Notes due 2017. Also, contributing to the decrease was a reduction in interest expense resulting from interest savings as a result of our 2014 and 2013 refinancings. Partially offsetting these decreases was a reduction in allowance for funds used during construction, which was mainly attributable to our Customer Information and Enterprise Asset Management systems being placed into service in 2013.

Provision for income taxes. In 2015 and 2014, our provision for income taxes increased $26 million and $43 million, or 9.3% and 18.1%, respectively, due primarily to the increase in pre-tax income. The effective tax rates were 39.1%, 39.4% and 39.0% for the years ended December 31, 2015, 2014 and 2013, respectively.

In December 2015, the accelerated tax benefit for bonus depreciation was legislatively extended for 2015-2019. Bonus depreciation applies to certain qualified capital investments placed into service and allows for a bonus depreciation provision of 50% from 2015 through 2017, 40% in 2018 and 30% in 2019. We have federal NOL carryforwards of $1.1 billion as of December 31, 2015. As such, the election of bonus depreciation will be annually determined on a state by state basis and will include, among other items, an evaluation of our ability to utilize our federal NOL carryforwards, charitable contribution carryforwards, and state regulatory practices. If we elect bonus depreciation for all years, we would not expect to pay federal income taxes until 2021.

Loss from discontinued operations, net of tax. As previously noted, the financial results of our Terratec line of business within our Market-Based Businesses was classified as discontinued operations for all periods presented. The sale of Terratec was completed in 2014. The 2014 loss from discontinued operations, net of tax includes the loss on sale, a tax valuation allowance and operating results.

Segment Results of Operations

Our segments are determined based on how we assess performance and allocate resources. We evaluate the performance of our segments and allocate resources based on several factors, with the primary measure being income from continuing operations.

We conduct our business primarily through one reportable segment, our Regulated Businesses segment. We also operate businesses that provide a broad range of related and complementary water and wastewater services in non-regulated markets, which

includes four operating segments that individually do not meet the criteria of a reportable segment. These four non-reportable segments have been combined and are presented as Market-Based Businesses, which is consistent with how management assesses the results of our businesses.

Regulated Businesses Segment

The following table summarizes certain financial information for our Regulated Businesses segment:

For the Years Ended December 31,
(In millions)201520142013
Operating revenues$2,743$2,674$2,594
Operation and maintenance1,0951,1121,105
Operating expenses, net1,7321,7261,700
Income from continuing operations473434400

Operating revenues. The following tables and discussions provide explanation of the variances related to the three components of operating revenues––water revenues, wastewater revenues and other revenues:

For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2015201420132015 vs. 20142014 vs. 2013
(In millions)Operating Revenues%%
Water service:
Residential$1,536$1,515$1,465$211.4$503.4
Commercial55955052191.6295.6
Industrial130132119(2)(1.5)1310.9
Public and other331333312(2)(0.6)216.7
Other water revenues3926181350.0844.4
Billed water services2,5952,5562,435391.51215.0
Unbilled water services(3)(25)3022(88.0)(55)(183.3)
Total water revenues$2,592$2,531$2,465$612.4$662.7
For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2015201420132015 vs. 20142014 vs. 2013
(In millions)Billed Water Sales Volume%%
Water service:
Residential (a)175,653176,975180,976(1,322)(0.7)(4,001)(2.2)
Commercial81,77281,56480,3922080.31,1721.5
Industrial38,99139,83337,107(842)(2.1)2,7267.3
Public and other51,32452,71051,009(1,386)(2.6)1,7013.3
Billed water services347,740351,082349,484(3,342)(1.0)1,5980.5
(a)The correlation between water service revenues and billed water sales volumes shown above is impacted by the California drought. California is experiencing a severe drought and in April 2015, the Governor mandated water usage restrictions to reduce overall water usage by 25% in the state compared to 2013 levels. Our California customers are largely meeting these conservation targets. Revenue in California is decoupled from sales volume, aligning our water conservation goals with those of the state and our customers and therefore these usage reductions do not impact earnings.

In 2015, water revenues increased $61 million, or 2.4%, primarily due to a:

·$45 million increase from rate increases and infrastructure charges;
·$24 million increase from higher demand, mainly due to milder weather in 2014;
·$5 million increase from acquisitions and organic growth; and
·$3 million incremental revenues for late payment and reconnection fees; partially offset by a
·$21 million decrease in surcharges and balancing accounts in our California subsidiary primarily related to the drought and the $5 million charge associated with the July 2015 application filed with the CPUC.

In 2014, water revenues increased $66 million, or 2.7%, primarily due to an:

·$80 million increase from rate increases and infrastructure charges; and
·$11 million increase in surcharges and balancing accounts; partially offset by a
·$27 million decrease resulting from a decline in consumption, mainly due to milder weather in 2014.
For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2015201420132015 vs. 20142014 vs. 2013
(In millions)Operating Revenues%%
Wastewater revenues$97$93$83$44.3$1012.0
Other revenues54504648.048.7

In 2015 and 2014, wastewater revenues increased primarily due to incremental revenues resulting from acquisitions.

In 2015 and 2014, other revenues increased primarily due to incremental revenues for late payments and reconnection fees, as well as insurance proceeds in 2014 for business interruption as a result of Hurricane Sandy.

Operation and maintenance. The following tables and discussions provide a detailed explanation of the variances related to the major components of operation and maintenance. In 2014, operation and maintenance was impacted by incremental costs of $10 million related to the Freedom Industries chemical spill in West Virginia, which included $6 million in other operation and maintenance, $3 million in operating supplies and services, and $1 million in employee-related costs.

For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2015201420132015 vs. 20142014 vs. 2013
(In millions)%%
Production costs$282$289$271$(7)(2.4)$186.6
Employee-related costs430430456——$(26)(5.7)
Operating supplies and services194217216(23)(10.6)$10.5
Maintenance materials and supplies70686622.9$23.0
Customer billing and accounting63615223.3$917.3
Other564744919.1$36.8
Total$1,095$1,112$1,105$(17)(1.5)$70.6

Production costs

For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2015201420132015 vs. 20142014 vs. 2013
(In millions)%%
Purchased water$117$121$111$(4)(3.3)$109.0
Fuel and power899286(3)(3.3)67.0
Chemicals48464824.3(2)(4.2)
Waste disposal283026(2)(6.7)415.4
Total$282$289$271$(7)(2.4)$186.6

In 2015, production costs decreased $7 million, or 2.4%, primarily due to a:

·$9 million decrease primarily due to lower usage in our California subsidiary as a result of statewide conservation initiatives, including decreases of $8 million in purchased water and $1 million in fuel and power; partially offset by a
·$4 million increase in purchased water primarily due to price increases in our Illinois and New Jersey subsidiaries.

In 2014, production costs increased $18 million, or 6.6%, primarily due to a:

·$10 million increase in purchased water costs primarily due to increased prices in our California subsidiary, and to a lesser extent, price increases in our Illinois subsidiary;
·$6 million increase in fuel and power costs due to higher supplier prices in several of our operating facilities, as well as incremental costs as a result of the Dale acquisition in the fourth quarter of 2013; and
·$4 million increase in waste disposal costs primarily due to an increase in the amount allowed by a cost recovery mechanism in one of our subsidiaries coupled with incremental costs related to the Dale acquisition.

Employee-related costs

For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2015201420132015 vs. 20142014 vs. 2013
(In millions)%%
Salaries and wages$321$328$323$(7)(2.1)$51.5
Pensions302748311.1(21)(43.8)
Group insurance60556659.1(11)(16.7)
Other benefits192019(1)(5.0)15.3
Total$430$430$456$——$(26)(5.7)

In 2015, employee-related costs remained consistent primarily due to a:

·$14 million reduction largely attributable to fewer employees and an increase in capital projects, which in turn resulted in higher capitalization rates; partially offset by a
·$14 million increase in pension costs and postretirement benefits costs, which is included in the group insurance line above, primarily due to the adoption of new mortality assumptions and a decrease in the discount rate resulting in increased plan obligations.

In 2014, employee-related costs decreased $26 million, or 5.7%, primarily due to a:

·$32 million reduction in pension and postretirement costs principally due to the change in assumptions used for the discount rate, which in turn decreased contributions. The decrease in contributions occurred at those regulated operating companies whose costs are recovered based on our funding policy, which is to fund at least the minimum amount required by the Employee Retirement Income Security Act of 1974; partially offset by a
·$5 million increase in salaries and wages primarily due to annual wage increases, increased overtime expense attributable to an increased number or main breaks as a result of harsh winter conditions and increases in severance expense as a result of the restructuring of certain functions.
Operating supplies and servicesFor the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2015201420132015 vs. 20142014 vs. 2013
(In millions)%%
Contracted services$81$88$94$(7)(8.0)(6)(6.4)
Office supplies and services444545(1)(2.2)——
Transportation162021(4)(20.0)(1)(4.8)
Rents141516(1)(6.7)(1)(6.3)
Other394940(10)(20.4)922.5
Total$194$217$216$(23)(10.6)$10.5

In 2015, operating supplies and services decreased $23 million, or 10.6%, primarily due to a:

·$5 million decrease in condemnation and conservation costs primarily due to initiatives in 2014 incurred by our California subsidiary;
·$3 million decrease in legal services;
·$3 million incremental costs in 2014 associated with the Freedom Industries chemical spill in West Virginia;
·$3 million adjustment attributable to the recognition of a regulatory asset for previously expensed business transformation costs as a result of the finalization of our California rate case; and
·$3 million decrease in transportation costs primarily due to lower fuel prices.

In 2014, operating supplies and services increased $1 million, or 0.5%, primarily due to a:

·$9 million increase in other operating supplies and services primarily due to an increase in condemnation and conservation costs related to one-time initiatives in our California subsidiary, as well as inclusion in 2013 of insurance proceeds for the recovery of expenses related to Hurricanes Irene and Sandy; partially offset by a
·$6 million decrease in contracted services as a result of completion of our business transformation project, which required the use of additional contracted services in 2013, partially offset by increases resulting from the Freedom Industries chemical spill in West Virginia mentioned above.

Market-Based Businesses

The following table summarizes certain financial information for our Market-Based Businesses:

For the Years Ended December 31,
(In millions)201520142013
Operating revenues$434$355$303
Operation and maintenance358289241
Operating expenses, net370300252
Income from continuing operations424039

Operating revenues. In 2015, operating revenues increased $79 million, or 22.3%, primarily due to a:

·$41 million increase in our Military Services Group revenues primarily due to additional construction project activities and the addition of two military contracts, Hill Air Force Base and Picatinny Arsenal, in the second half of 2015;
·$15 million increase in our Homeowner Services Group revenues primarily due to contract growth, mainly in New York City, and the expansion into other geographic areas; and
·$26 million increase resulting from Keystone; partially offset by a
·$3 million decrease in our Contract Operations Group revenues primarily due to attributable to the termination of certain municipal and industrial operations and maintenance contracts.

In 2014, operating revenues increased $52 million, or 17.2%, primarily due to a:

·$39 million increase in our Military Service Group revenues primarily resulting from an increase in construction project activities for our military contracts, which includes $5 million in price redeterminations for several of our military contracts; and
·$16 million increase in our Homeowners Services Group revenues primarily due to contract growth, mainly in New York City, as well as expansion into other geographic areas and price increases for certain existing customers; partially offset by a
·$3 million decrease in our Contract Operations Group revenues primarily due to the termination of certain municipal and industrial operations and maintenance contracts.

Operation and maintenance. The following table provides information regarding components of operation and maintenance:

For the Years Ended December 31,Increase (Decrease)Increase (Decrease)
2015201420132015 vs. 20142014 vs. 2013
(In millions)%%
Production costs$36$35$37$12.9%$(2)(5.4%)
Employee-related costs7662601422.6%23.3%
Operating supplies and services182138994431.9%3939.4%
Maintenance materials and supplies5747411021.3%614.6%
Other774——375.0%
Total$358$289$241$6923.9%$4819.9%

In 2015, operation and maintenance increased $69 million, or 23.9%, primarily due to a:

·$30 million increase in our Military Services Group operating supplies and services primarily due to increased construction project activities and the addition of two military contracts; and
·$24 million increase resulting from Keystone, including $9 million in employee-related costs, $14 million in operating supplies and services and $1 million in maintenance, materials, and supplies;
·$7 million increase in our Homeowner Services Group maintenance and supplies primarily due to higher repair costs incurred, which was attributable to the increase in the number of contracts.
·$5 million increase in our Military Services Group and Homeowners Services Group employee-related costs, which was attributable to the addition of two military contracts and increase in headcount.

In 2014, operation and maintenance increased $48 million, 19.9%, or primarily due to a:

·$35 million increase in operating supplies and services related to our Military Services Group primarily due to increased construction project activities;
·$4 million in loss contract reserves due to the resolution of certain outstanding issues and uncertainties; and
·$6 million increase in maintenance materials and supplies primarily due to higher repair costs incurred by our Homeowners Services Group, which was attributable to a higher volume of contracts.

Liquidity and Capital Resources

We regularly evaluate and monitor our cash requirements for capital investments, acquisitions, operations, commitments, debt service and dividends. Our business is capital intensive, with a majority of this capital funded by cash flows from operations. When necessary, we also obtain funds from external sources, primarily in the debt markets and through short-term commercial paper borrowings. We also have access to equity capital markets, if needed. Our access to external financing on reasonable terms depends on our credit ratings and current business conditions, including that of the utility and water utility industries in general, as well as conditions in the debt or equity capital markets and the national and international economic and geopolitical arenas. If these business, market, financial and other conditions deteriorate to the extent that we no longer are able to access the capital markets on reasonable terms, we have access to an unsecured revolving credit facility with aggregate bank commitments of $1.25 billion, with an expiration date of June 2020 (subject to extension by us for up to two one-year periods). We rely on this revolving credit facility and the capital markets to fulfill our short-term liquidity needs, to issue letters of credit and to support our commercial paper program. Disruptions in the credit markets may discourage lenders from extending the terms of such commitments or agreeing to new commitments. Market disruptions may also limit our ability to issue debt and equity securities in the capital markets. See “Credit Facility and Short-Term Debt” below for further discussion. In order to meet our short-term liquidity needs, we, through AWCC, our wholly owned financing subsidiary, issue commercial paper, which is supported by the revolving credit facility. AWCC had no outstanding borrowings and $82 million of outstanding letters of credit under its credit facility as of December 31, 2015. As of December 31, 2015, AWCC had $1.25 billion available under the credit facility that we could use to fulfill our short-term liquidity needs and to issue letters of credit, which supported our $626 million outstanding commercial paper. We believe that our ability to access the capital markets, our revolving credit facility and our cash flows from operations will generate sufficient cash to fund our short-term requirements. We have no plans to issue equity under normal operating conditions with the limited exception of privately or investor-owned tuck-in acquisitions whose sellers require equity as necessary to complete the acquisition. We believe we have sufficient liquidity and ability to manage our expenditures should there be a disruption of the capital and credit markets. However, there can be no assurances that our lenders will meet their existing commitments or that we will be able to access the commercial paper or loan markets in the future on terms acceptable to us or at all.

In addition, our regulated subsidiaries receive advances and contributions from customers, home builders and real estate developers to fund construction necessary to extend service to new areas. Advances for construction are refundable for limited periods, which vary according to state regulations, as new customers begin to receive service or other contractual obligations are fulfilled. Amounts which are no longer refundable are reclassified to contributions in aid of construction. Utility plant funded by advances and contributions is excluded from the rate base. Generally, we depreciate contributed property and amortize contributions in aid of construction at the composite rate of the related property. Some of our subsidiaries do not depreciate contributed property, based on regulatory guidelines.

We use our capital resources, including cash, primarily to; (i) fund operating and capital requirements; (ii) pay interest and meet debt maturities; (iii) pay dividends; (iv) fund pension and postretirement welfare obligations; and (v) fund acquisitions. We invest a significant amount of cash on regulated capital projects where we expect to earn a long-term return on investment. Additionally, we operate in rate-regulated environments in which the amount of new investment recovery may be limited, and where such recovery takes place over an extended period of time, as our recovery is subject to regulatory lag. See Item 1—Business—Operating Segments—Regulated Businesses—Economic Regulation and Rate Making Process. We expect to fund future maturities of long-term debt through a combination of external debt and, to the extent available, cash flows from operations. Since we expect our capital investments over the next few years to be greater than or equal to our cash flows from operating activities, we have no plans to reduce debt significantly.

If necessary, the Company may delay certain capital investments or other funding requirements or pursue financing from other sources to preserve liquidity, if necessary. In this event, we believe we can rely upon cash flows from operations to meet our obligations and fund our minimum required capital investments for an extended period of time.

Cash Flows Provided by Operating Activities

Cash flows provided by operating activities primarily result from the sale of water and wastewater services and, due to the seasonality of demand, are generally greater during the third quarter of each fiscal year. Our future cash flows provided by operating activities will be affected by, among other things, economic utility regulation; infrastructure investment; inflation; compliance with environmental, health and safety standards; production costs; customer growth; declining customer usage of water; employee-related costs, including pension funding; weather and seasonality; and overall economic conditions.

Cash flows provided by operating activities have been a reliable, steady source of funding, sufficient to meet operating requirements, make our dividend payments and fund a portion of our capital expenditure requirements. We expect to seek access to debt capital markets to meet the balance of our capital expenditure requirements as needed. We also have access to equity capital markets, if needed. Operating cash flows can be negatively affected by changes in our rate regulated environments or changes in our customers’ economic outlook and ability to pay for service in a timely manner. As such, our working capital needs are primarily limited to funding increases in customer accounts receivable and unbilled revenues mainly associated with revenue increases in our Regulated Businesses. We can provide no assurance that our customers’ historical payment pattern will continue in the future. We address cash timing differences through the liquidity funding mechanisms discussed above.

The following table provides a summary of the major items affecting our cash flows provided by operating activities:

For the Years Ended December 31,
201520142013
(In millions)
Net income$476$423$369
Add (less):
Non-cash activities (a)773723762
Changes in working capital (b)(13)3(137)
Pension and postretirement benefit contributions(57)(52)(98)
Net cash flows provided by operating activities$1,179$1,097$896
(a)Includes depreciation and amortization, provision for deferred income taxes and amortization of investment tax credits, provision for losses on accounts receivable, (gain) loss on asset dispositions and purchases, pension and non-pension postretirement benefits, and other non-cash items. Details of each component can be found in the Consolidated Statements of Cash Flows.
(b)Changes in working capital include changes to receivables and unbilled revenues, accounts payable and accrued liabilities, pension and non-pension postretirement benefit contributions, change in book overdraft and other current assets and liabilities.

In 2015, cash flows provided by operations increased $82 million primarily due to higher net income compared to the same period in 2014.

In 2014, cash flows provided by operations increased $201 million primarily due to an improvement in the cash collections of our Regulated Businesses’ accounts receivable, some of which were unbilled at December 31, 2013. Cash collections in 2013 for our Regulated Businesses’ accounts receivable were slower than historical payment patterns, mainly due to the implementation of our CIS system in May 2013. We implemented the CIS system in our remaining Regulated Businesses in October 2013 and experienced a similar slowdown in cash collections for these operating companies in 2014.

The Company expects to make pension and postretirement benefit contributions to the plan trusts of $55 million in 2016, of which $9 million was already made in 2016. In addition, we estimate that contributions will amount to $61 million in 2017, $79 million in 2018, $93 million in 2019 and $103 million in 2020. Actual amounts contributed could change materially from these estimates as a result of changes in assumptions and actual investment returns, among other factors.

Cash Flows Used in Investing Activities

Cash flows used in investing activities were as follows:

For the Years Ended December 31,
201520142013
(In millions)
Net capital expenditures$(1,160)$(956)$(980)
Proceeds from sale of assets and securities5141
Acquisitions(197)(9)(24)
Other investing activities, net (a)(113)(63)(50)
Net cash flows used in investing activities$(1,465)$(1,014)$(1,053)
(a)Includes removal costs from property, plant and equipment retirements, net and net funds released.

In 2015 and 2014, cash flows used in investing activities increased primarily due to an increase in our regulated capital expenditures, principally from incremental investments associated with the replacement and renewal of our transmission and distribution infrastructure.

Our infrastructure investment plan consists of both infrastructure renewal programs, where we replace infrastructure, as needed, and major capital investment projects, where we construct new water and wastewater treatment and delivery facilities to meet new customer growth and water quality regulations. Our projected capital expenditures and other investments are subject to periodic review and revision to reflect changes in economic conditions and other factors.

The following table provides a summary of our historical capital expenditures related to upgrading our infrastructure and systems:

For the Years Ended December 31,
201520142013
(In millions)
Transmission and distribution$527$463$436
Treatment and pumping1369789
Services, meter and fire hydrants214170178
General structure and equipment174142131
Business transformation project—860
Sources of supply533150
Wastewater564536
Total capital expenditures$1,160$956$980

In 2015, capital expenditures increased $204 million, or 21.3%, primarily due to continued investment across all infrastructure categories, mainly replacement and renewal of transmission and distribution infrastructure.

In 2014, capital expenditures decreased $24 million, or 2.5%, primarily due to the completion of Phase I and Phase II of our business transformation project in 2013, partially offset by increased infrastructure investment.

We also grow our business through acquisitions of water and wastewater systems, as well as other water-related services. These acquisitions are complementary to our existing business and support continued geographical diversification and growth of our operations. Generally, acquisitions are funded initially with short-term debt and later refinanced with the proceeds from long-term debt.

The following provides a summary of the acquisitions and dispositions affecting our cash flows from investing activities:

2015:

·Paid $133 million for the acquisition of our ninety five percent interest in Water Solutions Holdings, LLC, the parent company of Keystone Clearwater Solutions, LLC; and
·Paid $64 million for 14 water and wastewater systems representing approximately 24,000 customers
·Received $5 million for the sale of assets and securities.

2014:

·Paid $9 million for 13 water and wastewater systems representing approximately 4,500 customers.
·Received $14 million for the sale of assets and securities.

2013:

·Paid approximately $24 million for ten water and five wastewater systems, which added approximately 30,000 customers. The largest of these acquisitions was the acquisition of the stock of a wastewater system in Virginia with approximately 20,000 customers in November 2013.
·We received approximately $1 million for the sale of assets and securities.

As previously noted, we expect to invest $6.4 billion from 2016 through 2020. In 2016, we estimate that our total capital expenditures will be $1.3 billion, with $1.2 billion allocated to improving infrastructure in our Regulated Businesses segment and $100 million for acquisitions and strategic capital investments.

We are currently considering a plan to construct a new corporate headquarters to consolidate our support services and certain of our employees in our Market-Based Businesses within a single location. We are considering several locations within Camden, New Jersey for the new headquarters. The cost of construction, which would take several years to complete, is currently estimated to be up to $165 million, depending on the location selected and exclusive of any tax incentives that the Company may receive.

Cash Flows from Financing Activities

Our financing activities, primarily focused on funding infrastructure construction expenditures, include the issuance of long-term and short-term debt, primarily through AWCC. In addition, new infrastructure may be funded with customer advances and contributions in aid of construction (net of refunds), which amounted to $26 million for the years ended December 31, 2015 and 2014 and $19 million for the year ended December 31, 2013. Based on the needs of our regulated subsidiaries and the Company, AWCC may borrow funds or issue its debt in the capital markets and then, through intercompany loans, provides those borrowings to the regulated subsidiaries and the Company. The regulated subsidiaries and the Company are obligated to pay their portion of the respective principal and interest to AWCC in the amount necessary to enable AWCC to meet its debt service obligations. Because the Company’s borrowings are not a source of capital for the regulated subsidiaries, the Company is not able to recover the interest charges on the Company’s debt through regulated water and wastewater rates. As of December 31, 2015, AWCC has made long-term fixed rate loans and commercial paper loans to our Regulated Businesses amounting to $3.3 billion and $284 million, respectively. Additionally, as of December 31, 2015, AWCC has made long-term fixed rate loans and commercial paper loans to the Company totaling $1.2 billion and $344 million to the Company, respectively.

On May 7, 2015, the Company and AWCC filed with the SEC a universal shelf registration statement that enables us to meet our capital needs through the offer and sale to the public from time to time of an unlimited amount of various types of securities, including American Water common stock, preferred stock and other equity securities, and AWCC debt types of securities, all subject to market conditions and demand, general economic conditions, and as applicable, rating status. The shelf registration will expire in May 2018. During 2015, 2014 and 2013, $550 million, $500 million and $400 million, respectively, of debt securities were issued pursuant to this and predecessor registration statements.

The following long-term debt was issued in 2015:

CompanyTypeRateMaturityAmount
AWCCSenior notes—fixed rate3.40%-4.30%2025-2045$550
Other American Water subsidiariesPrivate activity bonds and government funded debt—fixed rate1.00%-1.56%203215
Total issuances$565
(a)On August 13, 2015, AWCC completed an offering of its senior fixed rate notes. Proceeds from this offering were used to lend funds to the Company and its regulated utilities, to refinance commercial paper borrowings and to finance redemptions of long-term debt.

In addition to the above issuances, we also assumed $1 million of debt as a result of an acquisition in 2015, which has a fixed interest rate of 1.00% and matures in 2040.

The following long-term debt was retired through optional redemption or payment at maturity during 2015:

CompanyTypeRateMaturityAmount (In millions)
AWCCPrivate activity bonds and government funded debt—fixed rate1.79%-5.25%2015-2031$36
AWCCSenior notes—fixed rate6.00%201530
Other American Water subsidiaries (a)Private activity bonds and government funded debt—fixed rate0.00%-5.40%2015-204161
Other American Water subsidiariesMandatorily redeemable preferred stock8.49%-9.18%2031-20364
Other American Water subsidiariesCapital lease payments—
Total retirements and redemptions$131
(a)Includes $2 million of non-cash redemptions resulting from the use of restricted funds.

The following long-term debt was issued in 2014:

CompanyTypeRateMaturityAmount (In millions)
AWCC (a)Senior notes—fixed rate3.40%-4.30%2025-2042$500
Other subsidiaries (b)Private activity bonds and government funded debt—fixed rate0.00%-5.00%2031-203310
Total issuances$510
(a)On August 14, 2014, AWCC completed an offering of its senior fixed rate notes. Proceeds from this offering were used to lend funds to the Company and its regulated utilities, to refinance commercial paper borrowings and to finance redemptions of long-term debt.
(b)Proceeds from the above issuance were received in 2014 and have been utilized to fund certain specific projects. $10.0 million of these proceeds are held in trust pending our certification that we have incurred qualifying capital expenditures. These issuances have been presented as non-cash on the Consolidated Statements of Cash Flows. Subsequent releases of all or a lesser portion of the funds by the trust are reflected as the release of restricted funds and are included in the investing activities in the Consolidated Statements of Cash Flows.

In addition to the above issuances, we also assumed $2 million of debt as a result of acquisitions in 2014.

The following long-term debt was retired through optional redemption or payment at maturity during 2014:

CompanyTypeRateMaturityAmount (In millions)
American Water Capital Corp.Private activity bonds and government funded debt—fixed rate6.00%-6.75%2018-2032$101
American Water Capital Corp.Senior notes—fixed rate6.00%203959
Other American Water subsidiaries (a)Private activity bonds and government funded debt—fixed rate0.00%-5.25%2014-204179
Other American Water subsidiariesMandatorily redeemable preferred stock8.49%-9.18%2031-20362
Other American Water subsidiariesCapital lease payments0
Total retirements and redemptions$241
(a)Includes $1.0 million of non-cash redemptions resulting from the use of restricted funds.

The following long-term debt was issued in 2013:

CompanyTypeRateMaturityAmount (In millions)
AWCC (a)Senior notes—fixed rate3.85%2024$400
AWCC (b)Private activity bonds and government funded debt—fixed rate2.30%-2.90%2021-20308
Other subsidiaries (c)Private activity bonds and government funded debt—fixed rate1.59%-2.41%2031-20333
Total issuances$411
(a)On November 20, 2013, AWCC completed an offering of its 3.85% senior fixed rate notes. Proceeds from the offering were used to refinance long-term debt and to repay commercial paper borrowings.
(b)Proceeds from these issuances were received in the fourth quarter of 2013 and have been utilized to fund certain specific projects. $7 million of these proceeds are held in trust pending our certification that we have incurred qualifying capital expenditures. These issuances have been presented as non-cash on the Consolidated Statements of Cash Flows. Subsequent releases of all or a lesser portion of the funds by the trust are reflected as the release of restricted funds and are included in the investing activities in the Consolidated Statements of Cash Flows.
(c)Proceeds from these issuances were received from the Pennsylvania Infrastructure Investment Authority and have been used to fund specified projects.

In addition to the above issuances, we also assumed $13 million of debt as a result of acquisitions in 2013, most of which is associated with the Dale Service Corporation stock acquisition in the fourth quarter of 2013.

The following long-term debt was retired through optional redemption or payment at maturity during 2013:

CompanyTypeRateMaturityAmount (In millions)
AWCC (a)Senior notes—fixed rate5.39%-10.00%2013-2017$476
Other subsidiaries (b)Private activity bonds and government funded debt—fixed rate0.00%-5.50%2013-204118
Other subsidiariesMortgage bonds—fixed rate6.59%20132
Other subsidiariesMandatorily redeemable preferred stock8.49%-9.18%2031-20362
Other subsidiariesCapital leases & other0
Total retirements and redemptions$498
(a)On October 8, 2013, we announced the purchase and retirement through a tender offer of $226 million in aggregate outstanding principal amount of our 6.08% Senior Notes due 2017. On October 8, 2013, we paid $272 million to effect the tender, which, in addition to the principal, included a repurchase premium of $39 million and accrued interest of $7 million. Also, in October 2013 and related to the tender, we recorded transaction fees of $1 million and a write-off of $1 million for unamortized debt issuance costs. The redemption was originally financed through commercial paper borrowing.
(b)Includes a $4 million of non-cash redemptions resulting from the use of restricted funds.

On November 1, 2013, we issued notices of redemption for $75 million and $75 million of outstanding Senior Notes with an original maturity date of 2038 and interest rates of 8.25% and 10.0%, respectively. These notes were retired on December 1, 2013.

Also on December 21, 2013, an additional $101 million in Senior Notes with an interest rate of 5.39% matured.

From time to time and as market conditions warrant, we may engage in long-term debt retirements via tender offers, open market repurchases or other viable alternatives to strengthen our balance sheets.

In February 2015, our Board of Directors authorized an anti-dilutive common stock repurchase program to mitigate the effect of shares issued through our dividend reinvestment, employee stock purchase and executive compensation activities. The program allows the Company to purchase up to 10 million shares of its outstanding common stock over an unrestricted period of time in the open market or through privately negotiated transactions. The program is conducted in accordance with Rule 10b-18 of the Exchange Act, and to facilitate the repurchases, the Company has also entered into a Rule 10b5-1 share repurchase plan with a third-party broker, which allows us to repurchase shares at times when we may otherwise be prevented from doing so under insider trading laws or because of self-imposed trading blackout periods. Subject to applicable regulations, the Company may elect to amend or cancel this repurchase program or the share repurchase parameters at its discretion. As of December 31, 2015, we have repurchased an aggregate of approximately 2.3 million shares of common stock under this program.

Credit Facility and Short-Term Debt

In June 2015, AWCC amended and restated the outstanding credit agreement, dated as of October 29, 2012, associated with the $1.25 billion aggregate commitment in unsecured revolving credit facility, to extend the expiration date of the facility from October 2018 to June 2020 and to allow AWCC to request to extend further the term of the credit facility for up to two one-year periods. An extension request must satisfy certain conditions and receive approval of the lenders, as set forth in the agreement. Interest rates on advances under the facility are based on a credit spread to the Eurodollar rate or base rate with the credit spread based AWCC’s Moody’s Investors Service, which we refer to as Moody’s, or Standard & Poor’s Ratings Services ratings, which we refer to as S&P, credit rating. At current ratings that spread would be 0.90%. The facility is used principally to support AWCC’s commercial paper program and to provide up to $150 million in letters of credit. Indebtedness under the facility is considered “debt” for purposes of a support agreement between American Water and AWCC, which serves as a functional equivalent of a guarantee by American Water of AWCC’s payment obligations under the credit facility.

Also, the Company acquired an additional revolving line of credit as part of its Keystone acquisition. The total commitment under this credit facility was $16 million of which $2 million was outstanding as of December 31, 2015.

The following table summarizes information regarding the Company’s aggregate credit facility commitments, letter of credit sub-limits and available funds under those revolving credit facilities, as well as outstanding amounts of commercial paper and outstanding borrowings under the respective facilities as of December 31, 2015 and 2014:

Outstanding
AvailableAvailableCommercial
Credit FacilityCredit FacilityLetter of CreditLetter of CreditPaperCredit Line
CommitmentCapacitySublimitCapacity(Net of Discount)Borrowing
(In millions)
December 31, 2015$1,266$1,182$150$68$626$2
December 31, 2014$1,250$1,212$150$112$450$—

The weighted-average interest rate on AWCC short-term borrowings for the years ended December 31, 2015 and 2014 was approximately 0.49% and 0.31%, respectively. Interest accrues on the Keystone revolving line of credit daily at a rate per annum equal to 2.75% above the greater of the one month or one day LIBOR.

Capital Structure

The following table indicates the percentage of our capitalization represented by the components of our capital structure as of December 31:

201520142013
Total common stockholders' equity43.5%45.2%44.6%
Long-term debt and redeemable preferred stock at redemption value50.6%50.1%49.3%
Short-term debt and current portion of long-term debt5.9%4.7%6.1%
Total100%100%100%

The changes in the capital structure between periods were mainly attributable to changes in outstanding commercial paper balances.

Debt Covenants

Our debt agreements contain financial and non-financial covenants. To the extent that we are not in compliance with these covenants such an event may create an event of default under the debt agreement and we or our subsidiaries may be restricted in our ability to pay dividends, issue new debt or access our revolving credit facility. For two of our smaller operating companies, we have informed our counterparties that we will provide only unaudited financial information at the subsidiary level, which resulted in technical non-compliance with certain of their reporting requirements under debt agreements with respect to $8 million of outstanding debt. We do not believe this event will materially impact us. Our long-term debt indentures contain a number of covenants that, among other things, limit the Company from issuing debt secured by the Company’s assets, subject to certain exceptions. Our failure to comply with any of these covenants could accelerate repayment obligations.

Certain long-term notes and the revolving credit facility require us to maintain a ratio of consolidated debt to consolidated capitalization (as defined in the relevant documents) of not more than 0.70 to 1.00. On December 31, 2015, our ratio was 0.56 to 1.00 and therefore we were in compliance with the covenant.

Security Ratings

Our access to the capital markets, including the commercial paper market, and respective financing costs in those markets, may be directly affected by our securities ratings. We primarily access the debt capital markets, including the commercial paper market, through AWCC. However, we have also issued debt through our regulated subsidiaries, primarily in the form of tax exempt securities or borrowings under state revolving funds, to lower our overall cost of debt.

On May 7, 2015, Standard and Poor’s (“S&P”) raised our corporate credit rating on AWCC and American Water from A- to A and our commercial paper rating from A-2 to A-1 on American water and AWCC. S&P also confirmed its stable rating outlook. On August 7, 2015, Moody’s upgraded the long-term ratings for American Water and AWCC from Baa1 to A3. At the same time, Moody’s also affirmed AWCC’s commercial paper rating at P2. Moody’s rating outlook for American Water and AWCC remains as stable.

Our long-term and short-term credit ratings as of December 31, 2015 are as follows:

Moody's InvestorsStandard & Poor's
SecuritiesServiceRatings Service
Senior unsecured debtA3A
Commercial paperP2A-1

A security rating is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the assigning rating agency, and each rating should be evaluated independently of any other rating. Security ratings are highly dependent upon our ability to generate cash flows in an amount sufficient to service our debt and meet our investment plans. We can provide no assurances that our ability to generate cash flows is sufficient to maintain our existing ratings. None of our borrowings are subject to default or prepayment as a result of the downgrading of these security ratings, although such a downgrading could increase fees and interest charges under our credit facility.

As part of the normal course of business, we routinely enter into contracts for the purchase and sale of water, energy, chemicals and other services. These contracts either contain express provisions or otherwise permit us and our counterparties to demand adequate assurance of future performance when there are reasonable grounds for doing so. In accordance with the contracts and applicable contract law, if we are downgraded by a credit rating agency, especially if such downgrade is to a level below investment grade, it is possible that a counterparty would attempt to rely on such a downgrade as a basis for making a demand for adequate assurance of future performance, which could include a demand that we provide collateral to secure our obligations. We do not expect to post any collateral which will have a material adverse impact on the Company’s results of operations, financial position or cash flows.

Dividends

Our Board of Directors authorizes the payment of dividends. The payment of dividends is subject to (sufficient liquidity, dividends from subsidiaries, etc.). The Company’s dividend rate on its common stock is determined by the Board of Directors on a quarterly basis and takes into consideration, among other factors, current and possible future developments that may affect the Company’s income and cash flows. Historically, dividends have been paid quarterly to holders of record approximately 15 days prior to the distribution date. Since the dividends on our common stock are not cumulative, only declared dividends are paid.

During 2015, 2014 and 2013, we paid $239 million, $216 million and $150 million in cash dividends, respectively. For 2015, we paid a cash dividend of $0.34 per share on December 1, September 1, June 1 and $0.31 per share on March 2. In 2014, we paid a cash dividend of $0.31 per share on December 1, September 2, June 2 and $0.28 on March 3. In 2013, we paid a cash dividend of $0.28 per share on December 2, September 3 and June 3.

On December 11, 2015, our Board of Directors declared a quarterly cash dividend payment of $0.34 per share payable on March 1, 2016 to shareholders of record as of February 8, 2016.

Regulatory Restrictions

The issuance by the Company or AWCC of long-term debt or equity securities does not require authorization of any state PUC if no guarantee or pledge of the regulated subsidiaries is utilized. However, state PUC authorization is required to issue long-term debt at most of our regulated subsidiaries. Our regulated subsidiaries normally obtain the required approvals on a periodic basis to cover their anticipated financing needs for a period of time or in connection with a specific financing.

Under applicable law, our subsidiaries can pay dividends only from retained, undistributed or current earnings. A significant loss recorded at a subsidiary may limit the dividends that the subsidiary can distribute to us.

Insurance Coverage

We carry various property, casualty and financial insurance policies with limits, deductibles and exclusions that we believe are consistent with industry standards. However, insurance coverage may not be adequate or available to cover unanticipated losses or claims. Additionally, annual policy renewals can be impacted by claims experience which in turn can impact coverage terms and conditions on a going forward basis. We are self-insured to the extent that losses are within the policy deductible or exceed the amount of insurance maintained. Such losses could have a material adverse effect on our short-term and long-term financial condition and our results of operations and cash flows.

Contractual Obligations and Commitments

We enter into contractual obligations with third parties in the ordinary course of business. Information related to our contractual obligations as of December 31, 2015 is summarized in the table below:

Contractual ObligationTotal1 Year or Less2-3 Years4-5 YearsMore Than 5 Years
(In millions)
Long-term debt obligations (a)$5,895$52$1,027$184$4,632
Interest on long-term debt (b)4,3693195944982,958
Operating lease obligations (c)12813231874
Purchase water obligations (d)610518987383
Other purchase obligations (e)140140———
Postretirement benefit plans' obligations (f)98224036—
Pension plan obligations (f)2923399160—
Preferred stocks with mandatory redemption requirements132335
Interest on preferred stock with mandatory redemption requirements71213
Other obligations (g)2,34697984797423
Total$13,898$1,612$2,724$1,084$8,478

Note: The above table reflects only financial obligations and commitments. Therefore, performance obligations associated with our Market-Based Businesses are not included in the above amounts. Also, uncertain tax positions of $233 million are not reflected in this table as we cannot predict when open tax years will close with completed examinations. See Note 13—Income Taxes in the Notes to the Consolidated Financial Statements.

(a)Represents sinking fund obligations and debt maturities.
(b)Represents expected interest payments on outstanding long-term debt. Amounts reported may differ from actual due to future financing of debt.
(c)Represents future minimum payments under non-cancelable operating leases, primarily for the lease of motor vehicles, buildings, land and other equipment including water facilities and systems constructed by partners under the Public-Private Partnerships described below.
(d)Represents future payments under water purchase agreements for minimum quantities of water.
(e)Represents the open purchase orders as of December 31, 2015, for goods and services purchased in the ordinary course of business.
(f)Represents contributions expected to be made to pension and postretirement benefit plans for the years 2016 through 2020.
(g)Includes an estimate of advances for construction to be refunded, capital expenditures estimated to be required under legal and binding contractual obligations, contracts entered into for energy purchases, a liability associated with a conservation agreement and service agreements.

Public-Private Partnerships

WVAWC has entered into a series of agreements with various public entities, which we refer to as the Partners, to establish certain joint ventures, commonly referred to as “public-private partnerships.” Under the public-private partnerships, WVAWC constructed utility plant, financed by WVAWC, and the Partners constructed utility plant (connected to WVAWC’s property), financed by the Partners. WVAWC agreed to transfer and convey some of its real and personal property to the Partners in exchange for an equal principal amount of Industrial Development Bonds, commonly referred to as IDBs, issued by the Partners under a state Industrial Development Bond and Commercial Development Act. WVAWC leased back the total facilities, including portions funded by both WVAWC and the Partners, under leases for a period of 40 years.

The leases have payments that approximate the payments required by the terms of the IDBs. These payments are considered “PILOT payments” which represent payments in lieu of taxes and approximate what WVAWC otherwise would pay as property taxes on the properties. We have presented the transaction on a net basis in the consolidated financial statements. The carrying value of the transferred facilities, which is presented in property, plant and equipment in the Consolidated Balance Sheets, was approximately $156 million as of December 31, 2015.

Performance Obligations

We have entered into agreements for the provision of services to water and wastewater facilities for the United States military, municipalities and other customers. These military services agreements expire between 2051 and 2065 and have remaining performance commitments as measured by estimated remaining contract revenues of $2.8 billion as of December 31, 2015. The operations and maintenance agreements with municipalities and other customers expire between 2015 and 2048 and have remaining performance commitments as measured by estimated remaining contract revenue of $795 million as of December 31, 2015. Some of the Company’s long-term contracts to operate and maintain a municipality’s, federal government’s or other party’s water or wastewater treatment and delivery facilities include responsibility for certain major maintenance for some of the facilities, in exchange for an annual fee.

Critical Accounting Policies and Estimates

The application of critical accounting policies is particularly important to our financial condition and results of operations and provides a framework for management to make significant estimates, assumptions and other judgments. Although our management believes that these estimates, assumptions and other judgments are appropriate, they relate to matters that are inherently uncertain. Accordingly, changes in the estimates, assumptions and other judgments applied to these accounting policies could have a significant impact on our financial condition and results of operations as reflected in our consolidated financial statements.

Our financial condition, results of operations and cash flows are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. Management believes that the areas described below require significant judgment in the application of accounting policy or in making estimates and assumptions in matters that are inherently uncertain and that may change in subsequent periods. Our management has reviewed these critical accounting policies, and the estimates and assumptions regarding them, with our audit committee. In addition, our management has also reviewed the following disclosures regarding the application of these critical accounting policies with the audit committee.

Regulatory Accounting

Our regulated utility subsidiaries are subject to regulation by state PUCs and the local governments of the states in which they operate. As such, we follow the authoritative accounting principles required for rate regulated entities, which requires us to reflect the effects of rate regulation in our financial statements. Use of the authoritative guidance is applicable to utility operations that meet the following criteria: (i) third-party regulation of rates; (ii) cost-based rates; and (iii) a reasonable assumption that rates will be set to recover the estimated costs of providing service plus a return on net investment, or rate base. As of December 31, 2015, we concluded that the operations of our regulated subsidiaries met the criteria.

Due to timing and other differences in the collection of revenue, these accounting principles allow a cost that would otherwise be charged as an expense by an unregulated entity to be capitalized as a regulatory asset if it is probable that such cost is recoverable through future rates; conversely, the principles allow creation of a regulatory liability for amounts collected in rates to recover costs expected to be incurred in the future or amounts collected in excess of costs incurred and are refundable to customers. Regulators may also impose certain fines or penalties.

As of December 31, 2015, we have recorded $1.3 billion of net regulatory assets and $402 million of regulatory liabilities within our consolidated financial statements. See Note 6—Regulatory Assets and Liabilities in the Notes to Consolidated Financial Statements for further information regarding the significant regulatory assets and liabilities.

For each regulatory jurisdiction where we conduct business, we assess at the end of each reporting period, or earlier, if appropriate, whether the regulatory assets and liabilities continue to meet the criteria for probable future recovery or settlement. This assessment includes consideration of factors such as changes in applicable regulatory environments, recent rate orders on recovery of a specific or similar incurred cost to other regulated entities in the same jurisdiction, the status of any pending or potential legislation that could impact the ability to recover costs through regulated rates. If subsequent events indicate that the regulatory assets or liabilities no longer meet the criteria for probable future recovery or settlement, our statement of operations and financial position could be materially affected. In addition, if we conclude in a future period that a separable portion of the business no longer meets the criteria, we are required to eliminate the financial statement effects of regulation for that part of the business, which would include the elimination of any or all regulatory assets and liabilities that had been recorded in the consolidated financial statements. Failure to meet the criteria of the authoritative guidance could materially impact our consolidated financial statements.

Goodwill

The Company has recorded $1.3 billion and $1.2 billion of goodwill at December 31, 2015 and 2014. The Company’s annual impairment test is performed as of November 30 of each year, in conjunction with the timing of the completion of the Company’s annual business plan. The Company also undertakes interim reviews when the Company determines that a triggering event that would more likely than not reduce the fair value of a reporting unit below its carrying value has occurred.

Entities assessing goodwill for impairment have the option of first performing a qualitative assessment to determine whether a quantitative assessment is necessary. In performing a qualitative assessment, the Company assess, among other things, macroeconomic conditions, industry and market considerations, overall financial performance, cost factors and entity specific events. If an entity determines, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not greater than the carrying amount, no further testing is required. If the entity bypasses the qualitative assessment or performs the qualitative assessment, but determines that it is more likely than not that its fair value is less than its carrying amount, a quantitative two-step, fair value-based test is performed.

The first step compares the estimated fair value of the reporting unit to its respective net carrying values, including goodwill, on the measurement date. If the estimated fair value of any reporting unit is less than such reporting unit’s carrying value, then the second step is performed to measure the amount of the impairment loss (if any) for such reporting unit.

The second step requires an allocation of fair value to the individual assets and liabilities using purchase price allocation accounting guidance in order to determine the implied fair value of goodwill. If the implied fair value of goodwill is less than the carrying amount for the reporting unit, an impairment loss is recorded as a reduction to goodwill and a charge to operating expense. Application of the goodwill impairment test requires significant management judgment, including the identification of reporting units and determining the fair value of the reporting unit. Management estimates fair value using a combination of a discounted cash flow analysis and market multiples analysis. Significant assumptions used in these fair value analyses include, but are not limited to, discount and growth rates and projected terminal values.

Excluding goodwill acquired in 2015 related to the Keystone acquisition, the Company determined that no qualitative factors were present that would indicate the estimated fair values of its reporting units were less than the respective carrying values. As such, the Company determined that the two-step goodwill impairment test was not necessary at November 30, 2015. Further, no triggering events occurred which required an impairment evaluation between the annual testing dates.

The Company recorded goodwill of $91 million as part of the Keystone acquisition. The Keystone business is an operating segment comprised of one reporting unit to which all of the goodwill arising from the acquisition was assigned. A step one test was completed for the Keystone goodwill. We used an income approach valuation technique which estimates the discounted future cash flows of operations. The discounted cash flow analysis relies on a single scenario reflecting the best estimate of projected cash flows. Significant assumptions were used in estimating the fair value, including the discount rate, growth rate and terminal value. The estimated fair value of the Keystone reporting unit exceeded its carrying value by less than 3%, and as such the Company does not believe the goodwill is impaired. If a further decline in the fair value were to occur, the Keystone reporting unit would be at risk of failing step one of the goodwill impairment test.

No impairment charge was recorded for goodwill for the years ended December 31, 2015, 2014 or 2013.

There can be no assurances that the Company will not be required to recognize an impairment of goodwill in the future due to market conditions or other factors related to the Company’s performance. These market events could include a decline over a period of time of the Company’s stock price, a decline over a period of time in valuation multiples of comparable water utilities and reporting unit companies, the lack of an increase in the Company’s market price consistent with its peer companies, decreases in control premiums or continued downward pressure on commodity prices. A decline in the forecasted results in our business plan, such as changes in rate case results or capital investment budgets or changes in our interest rates, could also result in an impairment charge. In regards to the Keystone goodwill, adverse developments in market conditions, including prolonged depression of natural gas prices or other factors that negatively impact our forecast operating results, cash flows or key assumptions in the future could result in an impairment charge of a portion or all of the goodwill balance.

Impairment of Long-Lived Assets

Long-lived assets include land, buildings, equipment and long-term investments. Long-lived assets, other than investments and land, are depreciated over their estimated useful lives, and are reviewed for impairment whenever changes in circumstances indicate the carrying value of the asset may not be recoverable. Such circumstances would include items such as a significant decrease in the market value of a long-lived asset, a significant adverse change in the manner in which the asset is being used or planned to be used or in its physical condition, or a history of operating or cash flow losses associated with the use of the asset. In addition, changes in the expected useful life of these long-lived assets may also be an impairment indicator. When such events or changes occur, we estimate the fair value of the asset from future cash flows expected to result from the use and, if applicable, the eventual disposition of the assets, and compare that to the carrying value of the asset. If the carrying value is greater than the fair value, an impairment loss is recognized equal to the amount by which the asset’s carrying value exceeds its fair value. The key variables that must be estimated include assumptions regarding sales volume, rates, operating costs, labor and other benefit costs, capital additions, assumed discount rates and other economic factors. These variables require significant management judgment and include inherent uncertainties since they are forecasting future events. A variation in the assumptions used could lead to a different conclusion regarding the realizability of an asset and, thus, could have a significant effect on the consolidated financial statements.

The long-lived assets of the regulated utility subsidiaries are grouped on a separate entity basis for impairment testing as they are integrated state-wide operations that do not have the option to curtail service and generally have uniform tariffs. A regulatory asset is charged to earnings if and when future recovery in rates of that asset is no longer probable.

The fair values of long-term investments are dependent on the financial performance and solvency of the entities in which we invest, as well as volatility inherent in the external markets. In assessing potential impairment for these investments, we consider these factors. If such assets are considered impaired, an impairment loss is recognized equal to the amount by which the asset’s carrying value exceeds its fair value.

Revenue Recognition

Revenues of the regulated utility subsidiaries are recognized as water and wastewater services are delivered to customers and include amounts billed to customers on a cycle basis and unbilled amounts based on estimated usage from the date of the meter reading associated with the latest customer bill to the end of the accounting period. Unbilled utility revenues as of December 31, 2015 and 2014 were $267 million and $221 million, respectively. Increases in volumes delivered to the utilities’ customers and rate mix due to changes in usage patterns in customer classes in the period could be significant to the calculation of unbilled revenue. Changes in the timing of meter reading schedules and the number and type of customers scheduled for each meter reading date would also have an effect on the estimated unbilled revenue.

Revenue from Market-Based Businesses is recognized as services are rendered. Revenues from certain construction projects are recognized over the contract term based on the costs incurred to date during the period compared to the total estimated costs over the entire contract. Losses on contracts are recognized during the period in which the loss first becomes probable and estimable. Revenues recognized during the period in excess of billings on construction contracts are recorded as unbilled revenue. Billings in excess of revenues recognized on construction contracts are recorded as other current liabilities on the balance sheet until the recognition criteria are met. Changes in contract performance and related estimated contract profitability may result in revisions to costs and revenues and are recognized in the period in which revisions are determined.

Accounting for Income Taxes

Significant management judgment is required in determining the provision for income taxes, primarily due to the uncertainty related to tax positions taken, as well as deferred tax assets and liabilities, valuation allowances and the utilization of net operating loss carryforwards.

In accordance with applicable authoritative guidance, we account for uncertain income tax positions using a benefit recognition model with a two-step approach, including a more-likely-than-not recognition threshold and a measurement approach based on the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement. If it is not more-likely-than-not that the benefit of the tax position will be sustained on its technical merits, no benefit is recorded. Uncertain tax positions that relate only to timing of when an item is included on a tax return are considered to have met the recognition threshold. Management evaluates each position based solely on the technical merits and facts and circumstances of the position, assuming the position will be examined by a taxing authority having full knowledge of all relevant information. Significant judgment is required to determine whether the recognition threshold has been met and, if so, the appropriate amount of unrecognized tax benefit to be recorded in the consolidated financial statements.

We evaluate the probability of realizing deferred tax assets quarterly by reviewing a forecast of future taxable income and our intent and ability to implement tax planning strategies, if necessary, to realize deferred tax assets. We also assess our ability to utilize tax attributes, including those in the form of carryforwards, for which the benefits have already been reflected in the financial statements. We record valuation allowances for deferred tax assets when we conclude it is more-likely-than-not such benefit will not be realized in future periods.

Actual income taxes could vary from estimated amounts due to the future impacts of various items, including changes in income tax laws, our forecasted financial condition and results of operations, failure to successfully implement tax planning strategies, recovery of taxes through the regulatory process for our Regulated Businesses, as well as results of audits and examinations of filed tax returns by taxing authorities. While we believe the resulting tax balances as of December 31, 2015 and 2014 are appropriately accounted for in accordance with the applicable authoritative guidance, the ultimate outcome of tax matters could result in favorable or unfavorable adjustments to our consolidated financial statements and such adjustments could be material. See Note 13—Income Taxes in the Notes to Consolidated Financial Statements for additional information regarding income taxes.

Accounting for Pension and Postretirement Benefits

We maintain noncontributory defined benefit pension plans covering eligible employees of our regulated utility and shared service operations. Benefits under the plans are based on the employee’s years of service and compensation. The pension plans were closed for most employees hired on or after January 1, 2006. Union employees hired on or after January 1, 2001 had their accrued benefit frozen and will be able to receive this benefit as a lump sum upon termination or retirement. Union employees hired on or after January 1, 2001 and non-union employees hired on or after January 1, 2006 are provided with a 5.25% of base pay defined contribution plan. We also maintain other postretirement benefit plans, which provide varying levels of medical and life insurance for eligible retirees. These retiree welfare plans are closed for union employees hired on or after January 1, 2006. The plans had previously closed for non-union employees hired on or after January 1, 2002. The Company also has several unfunded noncontributory supplemental non-qualified pension plans that provide additional retirement benefits to certain employees. The Company does not participate in a multiemployer plan. See Note 13 in the Notes to Consolidated Financial Statements for further information regarding the accounting for the defined benefit pension plans and postretirement benefit plans. The Company’s pension and postretirement benefit costs are developed from actuarial valuations. Inherent in these valuations are key assumptions provided by the Company to its actuaries, including the discount rate and expected long-term rate of return on plan assets. Material changes in the Company’s pension and postretirement benefit costs may occur in the future due to changes in these assumptions as well as fluctuations in plan assets. The assumptions are selected to represent the average expected experience over time and may differ in any one year from actual experience due to changes in capital markets and the overall economy. These differences will impact the amount of pension and other postretirement benefit expense that the Company recognizes. The primary assumptions are:

·Discount Rate—The discount rate is used in calculating the present value of benefits, which are based on projections of benefit payments to be made in the future. The objective in selecting the discount rate is to measure the single amount that, if invested at the measurement date in a portfolio of high-quality debt instruments, would provide the necessary future cash flows to pay the accumulated benefits when due;
·Expected Return on Plan Assets (“EROA”)—Management projects the future return on plan assets considering prior performance, but primarily based upon the plans’ mix of assets and expectations for the long-term returns on those asset classes. These projected returns reduce the net benefit costs we record currently;
·Rate of Compensation Increase—Management projects employees’ pay increases, which are used to project employees’ pension benefits at retirement;
·Health Care Cost Trend Rate—Management projects the expected increases in the cost of health care; and
·Mortality—In the determination of year end 2014 projected benefit obligations, Management adopted a new table based on the Society of Actuaries RP 2014 mortality table including a generational BB-2D projection scale. The adoption resulted in a significant increase to pension and other postretirement benefit plans’ projected benefit obligations.

The discount rate assumption, which is determined for the pension and postretirement benefit plans independently, is subject to change each year, consistent with changes in applicable high-quality, long-term corporate bond indices. We use an approach that approximates the process of settlement of obligations tailored to the plans’ expected cash flows by matching the plans’ cash flows to the coupons and expected maturity values of individually selected bonds. The yield curve was developed for a portfolio containing the majority of United States-issued AA-graded non-callable (or callable with make-whole provisions) corporate bonds. For each plan, the discount rate was developed as the level equivalent rate that would yield the same present value as using spot rates aligned with the projected benefit payments. The discount rate for determining pension benefit obligations was 4.66%, 4.24% and 5.12% at December 31, 2015, 2014 and 2013, respectively. The discount rate for determining other post-retirement benefit obligations was 4.67%, 4.24% and 5.10% at December 31, 2015, 2014 and 2013, respectively.

In selecting an expected return on plan assets, we considered tax implications, past performance and economic forecasts for the types of investments held by the plans. The long-term EROA assumption used in calculating pension cost was 6.91% for 2015, 6.91% for 2014, and 7.49% for 2013. The weighted average EROA assumption used in calculating other postretirement benefit costs was 4.92% for 2015, 5.87% for 2014 and 6.99% for 2013.

The asset allocations for the Company’s U.S. pension plan by asset category were as follows:

Target AllocationPercentage of Plan Assets as of December 31,
Asset Category201620152014
Equity securities52%50%51%
Fixed income40%41%41%
Real Estate6%7%6%
Real estate investment trusts (“REITs”)2%2%2%
Total100%100%100%

The investment policy guidelines of the pension plan require that the fixed income portfolio has an overall weighted average credit rating of AA or better by Standard & Poor’s and the minimum credit quality for fixed income securities must be BBB- or better. Up to 20% of the portfolio may be invested in collateralized mortgage obligations backed by the United States Government.

The Company’s other postretirement benefit plans are partially funded. The asset allocations for the Company’s other postretirement benefit plans by asset category were as follows:

Target AllocationPercentage of Plan Assets as of December 31,
Asset Category201620152014
Equity securities32%32%30%
Fixed income68%68%70%
REITs———%
Total100%100%100%

The Company’s investment policy, and related target asset allocation, is evaluated periodically through asset liability studies. The studies consider projected cash flows of maturity liabilities, projected asset class return risk, and correlation and risk tolerance.

The pension and postretirement welfare plan trusts investments include debt and equity securities held either directly or through commingled funds. The trustee for the Company’s defined benefit pension and postretirement welfare plans uses independent valuation firms to calculate the fair value of plan assets. Additionally, the Company independently verifies the assets values. Approximately 45.6% of the assets are valued using the quoted market price for the assets in an active market at the measurement date, while 54.4% of the assets are valued using other inputs.

In selecting a rate of compensation increase, we consider past experience in light of movements in inflation rates. Our rate of compensation increase was 3.10% for 2015, 3.12% for 2014 and 3.15% for 2013.

In selecting health care cost trend rates, we consider past performance and forecasts of increases in health care costs. Our health care cost trend rate used to calculate the periodic cost was 6.75% in 2015 gradually declining to 5.00% in 2021 and thereafter.

Assumed health care cost trend rates have a significant effect on the amounts reported for the other postretirement benefit plans. The health care cost trend rate is based on historical rates and expected market conditions. A one-percentage-point change in assumed health care cost trend rates would have the following effects:

Change in Actuarial AssumptionImpact on Other Postretirement Benefit Obligation as of December 31, 2015Impact on 2015 Total Service and Interest Cost Components
(In millions)
Increase assumed health care cost trend by 1%$99$8
Decrease assumed health care cost trend by 1%$(81)$(6)

We will use a discount rate and EROA of 4.66% and 7.02%, respectively, for estimating our 2016 pension costs. Additionally, we will use a discount rate and EROA of 4.67% and 5.20%, respectively, for estimating our 2016 other postretirement benefit costs. A decrease in the discount rate or the EROA would increase our pension expense. Our 2015 and 2014 pension and postretirement costs, including such expenses charged to our discontinued operations, were $61 million and $24 million, respectively. The Company expects to make pension and postretirement benefit contributions to the plan trusts of $55 million, $61 million, $79 million, $93 million and $103 million in 2016, 2017, 2018, 2019 and 2020, respectively. Actual amounts contributed could change significantly from these estimates. The assumptions are reviewed annually and at any interim re-measurement of the plan obligations. The impact of assumption changes is reflected in the recorded pension and postretirement benefit amounts as they occur, or over a period of time if allowed under applicable accounting standards. As these assumptions change from period to period, recorded pension and postretirement benefit amounts and funding requirements could also change.

Accounting for Contingencies

We record loss contingencies when management determines that the outcome of future events is probable of occurring and when the amount of the loss can be reasonably estimated. The determination of a loss contingency is based on management judgment and estimates about the likely outcome of the matter, which may include an analysis of different scenarios. Liabilities are recorded or adjusted when events or circumstances cause these judgments or estimates to change. In assessing whether a loss is reasonably possible, management considers many factors, which include, but are not limed to: the nature of the litigation, claim or assessment, available information, opinions or views of legal counsel and other advisors, and the experience gained from similar cases or situations. We provide disclosures for material contingencies when management deems there is a reasonable possibility that a loss or an additional loss may be incurred. We provide estimates of reasonably possible losses when such estimates may be reasonably determined, either as a single amount or within a reasonable range.

Actual amounts realized upon settlement of contingencies may be different than amounts recorded and disclosed and could have a significant impact on the liabilities, revenue and expenses recorded on the consolidated financial statements. For a discussion of contingencies, see Note 15—Commitments and Contingencies in the Notes to Consolidated Financial Statements.

New Accounting Standards

See Note 2—Significant Accounting Policies in the Notes to Consolidated Financial Statements for a description of recent accounting standards.

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