Employee Benefit Plans

Pension and Postretirement Plans

The following table provides a reconciliation of the projected benefit obligations and plan assets for our pension plans and accumulated benefit obligations for our other postretirement benefit plans:



	Millions of Dollars
	Pension Benefits									Other Benefits
	2016					2015				2016		2015
	U.S.			Int’l.		U.S.		Int’l.
Change in Benefit Obligation
Benefit obligation at January 1	$	2,791		912		2,895		941		219		203
Service cost	127			32		124		38		7		7
Interest cost	116			28		109		28		8		7
Plan participant contributions	—			3		—		3		2		1
Actuarial loss (gain)	62			237		(25	)	(10	)	(6	)	13
Benefits paid	(215		)	(19	)	(312	)	(20	)	(13	)	(12	)
Curtailment gain	—			(31	)	—		—		—		—
Acquisition of a business	—			—		—		—		8		—
Foreign currency exchange rate change	—			(107	)	—		(68	)	—		—
Benefit obligation at December 31	$	2,881		1,055		2,791		912		225		219

Change in Fair Value of Plan Assets
Fair value of plan assets at January 1	$	2,023		742		2,124		724		—		—
Actual return on plan assets	136			148		(10	)	18		—		—
Company contributions	330			40		221		63		11		11
Plan participant contributions	—			3		—		3		2		1
Benefits paid	(215		)	(19	)	(312	)	(20	)	(13	)	(12	)
Foreign currency exchange rate change	—			(118	)	—		(46	)	—		—
Fair value of plan assets at December 31	$	2,274		796		2,023		742		—		—

Funded Status at December 31	$	(607	)	(259	)	(768	)	(170	)	(225	)	(219	)

Amounts recognized in the consolidated balance sheet for our pension and other postretirement benefit plans at December 31, 2016 and 2015, include:



	Millions of Dollars
	Pension Benefits									Other Benefits
	2016					2015				2016		2015
	U.S.			Int’l.		U.S.		Int’l.
Amounts Recognized in the Consolidated Balance Sheet at December 31
Noncurrent assets	$	—		—		—		20		—		—
Current liabilities	(10		)	—		(10	)	—		(10	)	(10	)
Noncurrent liabilities	(597		)	(259	)	(758	)	(190	)	(215	)	(209	)
Total recognized	$	(607	)	(259	)	(768	)	(170	)	(225	)	(219	)

Included in accumulated other comprehensive income/loss at December 31 were the following before-tax amounts that had not been recognized in net periodic benefit cost:



	Millions of Dollars
	Pension Benefits							Other Benefits
	2016				2015			2016		2015
	U.S.		Int’l.		U.S.	Int’l.

Unrecognized net actuarial loss (gain)	$	684	227		710	143		(5	)	2
Unrecognized prior service cost (credit)	3		(5	)	6	(7	)	(9	)	(10	)



	Millions of Dollars
	Pension Benefits									Other Benefits
	2016					2015				2016		2015
	U.S.			Int’l.		U.S.		Int’l.
Sources of Change in Other Comprehensive Income/Loss
Net gain (loss) arising during the period	$	(54	)	(129	)	(124	)	7		7		(14	)
Curtailment gain	—			31		—		—		—		—
Amortization of (gain) loss and settlements included in income	80			14		155		15		—		(1	)
Net change during the period	$	26		(84	)	31		22		7		(15	)

Prior service cost arising during the period	$	—		—		—		—		—		—
Amortization of prior service cost (credit) included in income	3			(1	)	3		(1	)	(1	)	(2	)
Net change during the period	$	3		(1	)	3		(1	)	(1	)	(2	)

The accumulated benefit obligations for all U.S. and international pensions plans were $2,601 million and $880 million, respectively at December 31, 2016, and $2,485 million and $712 million, respectively, at December 31, 2015.

Information for U.S. and international pension plans with an accumulated benefit obligation in excess of plan assets at December 31 were:



	Millions of Dollars
	Pension Benefits
	2016			2015
	U.S.		Int’l.	U.S.	Int’l.

Projected benefit obligations	$	2,881	1,055	2,791	351
Accumulated benefit obligations	2,601		880	2,485	303
Fair value of plan assets	2,274		796	2,023	160

Components of net periodic benefit cost for all defined benefit plans are presented in the table below:



	Millions of Dollars
	Pension Benefits													Other Benefits
	2016					2015				2014				2016		2015		2014
	U.S.			Int’l.		U.S.		Int’l.		U.S.		Int’l.
Components of Net Periodic Benefit Cost
Service cost	$	127		32		124		38		121		38		7		7		7
Interest cost	116			28		109		28		108		35		8		7		8
Expected return on plan assets	(128		)	(38	)	(138	)	(37	)	(142	)	(37	)	—		—		—
Amortization of prior service cost (credit)	3			(1	)	3		(1	)	3		(2	)	(1	)	(2	)	(1	)
Recognized net actuarial loss (gain)	72			14		75		15		40		12		—		(1	)	(2	)
Settlements	8			—		80		—		—		—		—		—		—
Total net periodic benefit cost	$	198		35		253		43		130		46		14		11		12

In determining net periodic benefit cost, we amortize prior service costs on a straight-line basis over the average remaining service period of employees expected to receive benefits under the plan. For net actuarial gains and losses, we amortize 10 percent of the unamortized balance each year. The amount subject to amortization is determined on a plan-by-plan basis. Amounts included in accumulated other comprehensive income at December 31, 2016, that are expected to be amortized into net periodic benefit cost during 2017 are provided below:



	Millions of Dollars
	Pension Benefits				Other Benefits
	U.S.		Int’l.

Unrecognized net actuarial loss	$	70	23		—
Unrecognized prior service cost (credit)	3		(1	)	(1	)

The following weighted-average assumptions were used to determine benefit obligations and net periodic benefit costs for years ended December 31:



	Pension Benefits					Other Benefits
	2016			2015		2016	2015
	U.S.		Int’l.	U.S.	Int’l.
Assumptions Used to Determine Benefit Obligations:
Discount rate	3.95	%	2.42	4.35	3.35	3.65	4.00
Rate of compensation increase	4.00		3.78	4.00	3.65	—	—

Assumptions Used to Determine Net Periodic Benefit Cost:
Discount rate	4.35	%	3.35	3.90	3.10	4.00	3.70
Expected return on plan assets	6.75		5.31	7.00	5.15	—	—
Rate of compensation increase	4.00		3.65	4.00	3.20	—	—

For both U.S. and international pension plans, the overall expected long-term rate of return is developed from the expected future return of each asset class, weighted by the expected allocation of pension assets to that asset class. We rely on a variety of independent market forecasts in developing the expected rate of return for each class of assets.

Our other postretirement benefit plans for health insurance are contributory. Effective December 31, 2012, we terminated the subsidy for retiree medical plans. Since January 1, 2013, eligible employees have been able to utilize notional amounts credited to an account during their period of service with the company to pay all, or a portion, of their cost to participate in postretirement health insurance through the company. In general, employees hired after December 31, 2012, will not receive credits to an account, but will have unsubsidized access to health insurance through the plan. The cost of health insurance will be adjusted annually by the company’s actuary to reflect actual experience and expected health care cost trends. The measurement of the accumulated benefit obligation assumes a health care cost trend rate of 6.50 percent in 2017 that declines to 5.00 percent by 2023. A one percentage-point change in the assumed health care cost trend rate would be immaterial to Phillips 66.

Plan Assets

The investment strategy for managing pension plan assets is to seek a reasonable rate of return relative to an appropriate level of risk and provide adequate liquidity for benefit payments and portfolio management. We follow a policy of diversifying pension plan assets across asset classes, investment managers, and individual holdings. As a result, our plan assets have no significant concentrations of credit risk. Asset classes that are considered appropriate include equities, fixed income, cash, real estate and insurance contracts. Plan fiduciaries may consider and add other asset classes to the investment program from time to time. The target allocations for plan assets are approximately 62 percent equity securities, 37 percent debt securities and 1 percent in all other types of investments. Generally, the investments in the plans are publicly traded, therefore minimizing the liquidity risk in the portfolio.

The following is a description of the valuation methodologies used for the pension plan assets.


•	Fair values of equity securities and government debt securities are based on quoted market prices.


•	Fair values of mutual funds are valued based on quoted market prices, which represent the net asset value of shares held.


•	Cash and cash equivalents are valued at cost, which approximates fair value.


•	Fair values of insurance contracts are valued at the present value of the future benefit payments owed by the insurance company to the plans’ participants.


•	Fair values of real estate investments are valued using real estate valuation techniques and other methods that include reference to third-party sources and sales comparables where available.


•	Fair values of investments in common/collective trusts are valued at net asset value (NAV) as determined by the issuer of each fund. Certain investments that are measured at fair value using the NAV value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy.

The fair values of our pension plan assets at December 31, by asset class, were as follows:



	Millions of Dollars
	U.S.					International
	Level 1		Level 2	Level 3	Total	Level 1	Level 2	Level 3	Total
2016
Equity securities	$	533	—	—	533	—	—	—	—
Mutual funds	47		—	—	47	—	—	—	—
Cash and cash equivalents	21		—	—	21	5	—	—	5
Insurance contracts	—		—	—	—	—	—	13	13
Real estate	—		—	—	—	—	—	6	6
Total assets in the fair value hierarchy	601		—	—	601	5	—	19	24
Common/collective trusts measured at NAV					1,673				772
Total	$	601	—	—	2,274	5	—	19	796



	Millions of Dollars
	U.S.					International
	Level 1		Level 2	Level 3	Total	Level 1	Level 2	Level 3	Total
2015
Equity securities	$	447	—	—	447	235	—	—	235
Government debt securities	—		—	—	—	144	—	—	144
Mutual funds	41		—	—	41	—	—	—	—
Cash and cash equivalents	22		—	—	22	3	—	—	3
Insurance contracts	—		—	—	—	—	—	13	13
Real estate	—		—	—	—	—	—	6	6
Total assets in the fair value hierarchy	510		—	—	510	382	—	19	401
Common/collective trusts measured at NAV					1,513				339
Other receivables					—				2
Total	$	510	—	—	2,023	382	—	19	742

As reflected in the table above, Level 3 activity was not material.

Our funding policy for U.S. plans is to contribute at least the minimum required by the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986, as amended. Contributions to international plans are subject to local laws and tax regulations. Actual contribution amounts are dependent upon plan asset returns, changes in pension obligations, regulatory environments, and other economic factors. In 2017, we expect to contribute approximately $130 million to our U.S. pension plans and other postretirement benefit plans and $35 million to our international pension plans.

The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid by us in the years indicated:



	Millions of Dollars
	Pension Benefits			Other Benefits
	U.S.		Int’l.

2017	$	301	18	25
2018	294		20	26
2019	278		20	26
2020	272		21	24
2021	279		23	23
2022-2025	1,278		140	98

Defined Contribution Plans

Most U.S. employees are eligible to participate in the Phillips 66 Savings Plan (Savings Plan). Employees can contribute up to 75 percent of their eligible pay, subject to certain statutory limits, in the thrift feature of the Savings Plan to a choice of investment funds. Phillips 66 provides a company match of participant thrift contributions up to 5 percent of eligible pay. In addition, participants who contribute at least 1 percent to the Savings Plan are eligible for “Success Share,” a semi-annual discretionary company contribution to the Savings Plan that can range from 0 to 6 percent of eligible pay, with a target of 2 percent. The total expense related to participants in the Savings Plan was $99 million, $134 million and $112 million in 2016, 2015 and 2014, respectively.

Share-Based Compensation Plans

In accordance with the Employee Matters Agreement related to the Separation, compensation awards based on ConocoPhillips stock and granted before April 30, 2012 (the Separation Date) were converted to compensation awards based on both ConocoPhillips and Phillips 66 stock if, on the Separation Date, the awards were: (1) options outstanding and exercisable; or (2) restricted stock or restricted stock units (RSUs) awarded for completed performance periods under the ConocoPhillips Performance Share Program. Phillips 66 restricted stock, RSUs and options issued in this conversion became subject to the “Omnibus Stock and Performance Incentive Plan of Phillips 66” (the 2012 Plan) on the Separation Date, whether held by grantees working for the company or grantees that remained employees of ConocoPhillips. Some of these awards based on Phillips 66 stock and held by employees of ConocoPhillips are still outstanding and appear in the activity tables for the Stock Option and the Performance Share Programs presented later in this footnote.

In May 2013, shareholders approved the 2013 Omnibus Stock and Performance Incentive Plan of Phillips 66 (the P66 Omnibus Plan). Subsequent to this approval, all new share-based awards are granted under the P66 Omnibus Plan, which authorizes the Human Resources and Compensation Committee of our Board of Directors (the Committee) to grant stock options, stock appreciation rights, stock awards (including restricted stock and RSU awards), cash awards, and performance awards to our employees, non-employee directors and other plan participants. The number of shares that may be issued under the P66 Omnibus Plan to settle share-based awards may not exceed 45 million.

Our share-based compensation programs generally provide accelerated vesting (i.e., a waiver of the remaining period of service required to earn an award) for awards held by employees at the time they become eligible for retirement. We recognize share-based compensation expense over the shorter of: (1) the service period (i.e., the stated period of time required to earn the award); or (2) the period beginning at the start of the service period and ending when an employee first becomes eligible for retirement, but not less than six months as this is the minimum period of time required for an award not to be subject to forfeiture.

Some of our share-based awards vest ratably (i.e., portions of the award vest at different times) while some of our awards cliff vest (i.e., all of the award vests at the same time). The company made a policy election to recognize expense on a straight-line basis over the service period for the entire award, whether the award was granted with ratable or cliff vesting.

Total share-based compensation expense recognized in income and the associated tax benefits for the years ended December 31 were as follows:



	Millions of Dollars
	2016			2015		2014

Share-based compensation expense	$	156		144		134
Tax benefit	(59		)	(54	)	(50	)

Stock Options

Stock options granted under the provisions of the P66 Omnibus Plan and earlier plans permit purchase of our common stock at exercise prices equivalent to the average market price of the stock on the date the options were granted. The options have terms of 10 years and generally vest ratably, with one-third of the options awarded vesting and becoming exercisable on each anniversary date for the three years following the date of grant. Options awarded to employees already eligible for retirement vest within six months of the grant date, but those options do not become exercisable until the end of the normal vesting period.

The following table summarizes our stock option activity from January 1, 2016, to December 31, 2016:



							Millions of Dollars
	Options		Weighted- Average Exercise Price		Weighted-Average Grant-Date Fair Value		Aggregate Intrinsic Value

Outstanding at January 1, 2016	5,431,739		$	41.27
Granted	818,100		78.86		$	16.94
Forfeited	(24,465	)	77.85
Exercised	(1,122,244	)	30.53				$	58
Expired or canceled	—		—
Outstanding at December 31, 2016	5,103,130		$	49.48

Vested at December 31, 2016	4,625,221		$	46.60			$	185

Exercisable at December 31, 2016	3,684,109		$	39.06			$	175

The weighted-average remaining contractual terms of vested options and exercisable options at December 31, 2016, were 5.36 years and 4.56 years, respectively. During 2016, we received $34 million in cash and realized a tax benefit of $16 million from the exercise of options. At December 31, 2016, the remaining unrecognized compensation expense from unvested options was $5 million, which will be recognized over a weighted-average period of 21 months, the longest period being 27 months. The calculations of realized tax benefit and weighted-average periods include awards based on both Phillips 66 and ConocoPhillips stock held by Phillips 66 employees.

During 2015 and 2014, we granted options with a weighted-average grant-date fair value of $18.84 and $18.95, respectively. During 2015 and 2014, employees exercised options with an aggregate intrinsic value of $60 million and $89 million, respectively.

The following table provides the significant assumptions used to calculate the grant date fair market values of options granted over the years shown below, as calculated using the Black-Scholes-Merton option-pricing model:



	2016		2015	2014
Assumptions used
Risk-free interest rate	1.71	%	1.60	1.96
Dividend yield	3.00	%	3.00	3.00
Volatility factor	28.68	%	34.17	34.97
Expected life (years)	7.08		6.66	6.23

After the Separation and through 2015, we calculated the volatility of options granted using a formula that adjusts the pre-Separation historical volatility of ConocoPhillips by the ratio of Phillips 66 implied market volatility on the grant date divided by the pre-Separation implied market volatility of ConocoPhillips. In 2016, we started calculating the volatility using historical Phillips 66 end-of-week closing stock prices from the Separation date.

We calculate the average period of time elapsed between grant dates and exercise dates of past grants to estimate the expected life of new option grants.

Restricted Stock Unit Program

Generally, RSUs are granted annually under the provisions of the P66 Omnibus Plan and cliff vest at the end of three years. Most RSU awards granted prior to the Separation vested ratably over five years, with one-third of the units vesting in 36 months, one-third vesting in 48 months, and the final third vesting 60 months from the date of grant. In addition to the regularly scheduled annual awards, RSUs are also granted ad hoc to attract or retain key personnel, and the terms and conditions under which these RSUs vest vary by award. Upon vesting, RSUs are settled by issuing one share of Phillips 66 common stock per RSU. RSUs awarded to employees already eligible for retirement vest within six months of the grant date, but those units are not issued as shares until the end of the normal vesting period. Until issued as stock, most recipients of RSUs receive a quarterly cash payment of a dividend equivalent, and for this reason the grant date fair value of these units is deemed equal to the average Phillips 66 stock price on the date of grant. The grant date fair market value of RSUs that do not receive a dividend equivalent while unvested is deemed equal to the average Phillips 66 common stock price on the grant date, less the net present value of the dividend equivalents that will not be received.

The following table summarizes our RSU activity from January 1, 2016, to December 31, 2016:



					Millions of Dollars
	Stock Units		Weighted-Average Grant-Date Fair Value		Total Fair Value

Outstanding at January 1, 2016	3,134,615		$	60.19
Granted	955,923		78.56
Forfeited	(48,877	)	75.33
Issued	(1,398,522	)	51.27		$	109
Outstanding at December 31, 2016	2,643,139		$	71.28

Not Vested at December 31, 2016	1,656,407		$	72.06

At December 31, 2016, the remaining unrecognized compensation cost from the unvested RSU awards was $48 million, which will be recognized over a weighted-average period of 21 months, the longest period being 49 months.

During 2015 and 2014, we granted RSUs with a weighted-average grant-date fair value of $74.09 and $73.28, respectively. During 2015 and 2014, we issued shares with an aggregate fair value of $107 million and $116 million, respectively, to settle RSUs.

Performance Share Program

Under the P66 Omnibus Plan, we also annually grant to senior management restricted performance share units (PSUs) that vest: (1) with respect to awards for performance periods beginning before 2009, when the employee becomes eligible for retirement by reaching age 55 with five years of service; or (2) with respect to awards for performance periods beginning in 2009, five years after the grant date of the award (although recipients can elect to defer the lapsing of restrictions until retirement after reaching age 55 with five years of service); or (3) with respect to awards for performance periods beginning in 2013 or later, on the grant date.

For PSU awards with performance periods beginning before 2013, we recognize compensation expense beginning on the date authorized and ending on the date the PSUs are scheduled to vest; however, since these awards are authorized three years prior to the grant date, we recognize compensation expense for employees that will become eligible for retirement by or shortly after the grant date over the period beginning on the date of authorization and ending on the date of grant. Since PSU awards with performance periods beginning in 2013 or later vest on the grant date, we recognize compensation expense beginning on the date of authorization and ending on the grant date for all employees participating in the PSU grant.

We settle PSUs with performance periods beginning before 2013 by issuing one share of Phillips 66 common stock for each PSU. Recipients of these PSUs receive a quarterly cash payment of a dividend equivalent beginning on the grant date and ending on the settlement date.

We settle PSUs with performance periods beginning in 2013 or later by paying cash equal to the fair value of the PSU on the grant date, which is also the date the PSU vests. Since these PSUs vest and settle on the grant date, dividend equivalents are never paid on these awards.

The following table summarizes our PSU activity from January 1, 2016, to December 31, 2016:



					Millions of Dollars
	Performance Share Units		Weighted-Average Grant-Date Fair Value		Total Fair Value

Outstanding at January 1, 2016	3,556,826		$	50.11
Granted	767,561		78.62
Forfeited	—		—
Issued	(317,329	)	50.03		$	26
Cash settled	(767,561	)	78.62		60
Outstanding at December 31, 2016	3,239,497		$	50.12

Not Vested at December 31, 2016	561,376		$	52.45

At December 31, 2016, the remaining unrecognized compensation cost from unvested PSU awards held by employees of Phillips 66 was $9 million, which will be recognized over a weighted-average period of 29 months, the longest period being 10 years. The calculations of unamortized expense and weighted-average periods include awards based on both Phillips 66 and ConocoPhillips stock held by Phillips 66 employees.

During 2015 and 2014, we granted PSUs with a weighted-average grant-date fair value of $74.14 and $72.26, respectively. During 2015 and 2014, we issued shares with an aggregate fair value of $37 million and $13 million, respectively, to settle PSUs. No PSUs were cash settled in 2015 or 2014.