PENSION AND OTHER POSTRETIREMENT BENEFITS

We have defined benefit pension plans that cover certain employees in the U.S., Germany, the UK and Canada. Pension benefits under defined benefit pension plans are based on years of service and, for certain plans, on average compensation for specified years preceding retirement. We fund pension costs in accordance with the funding requirements of the Employee Retirement Income Security Act of 1974 (ERISA), as amended, for U.S. plans and in accordance with local regulations or customs for non-U.S. plans. Beginning in 2017, the accrued benefit for all participants in the Kennametal Inc. Retirement Income Plan is frozen as the result of amendment. The majority of our defined benefit pension plans are closed to future participation.

We have an Executive Retirement Plan for various executives and a Supplemental Executive Retirement Plan both of which have been closed to future participation on June 15, 2017 and July 26, 2006, respectively.

We presently provide varying levels of postretirement health care and life insurance benefits to certain employees and retirees. Postretirement health care benefits are available to employees and their spouses retiring on or after age 55 with 10 or more years of service. Beginning with retirements on or after January 1, 1998, our portion of the costs of postretirement health care benefits is capped at 1996 levels. Beginning with retirements on or after January 1, 2009, we have no obligation to provide a company subsidy for retiree medical costs. Postretirement health and life benefits are closed to future participants as of December 31, 2016.

We use a June 30 measurement date for all of our plans.

Defined Benefit Pension Plans

The funded status of our pension plans and amounts recognized in the consolidated balance sheets as of June 30 were as follows:



(in thousands)	2017			2016
Change in benefit obligation:
Benefit obligation, beginning of year	$	1,005,368		$	954,454
Service cost	2,908			4,640
Interest cost	31,113			37,726
Participant contributions	8			6
Actuarial (gains) losses	(19,660		)	86,425
Benefits and expenses paid	(70,257		)	(45,074		)
Currency translation adjustments	(1,045		)	(19,283		)
Plan amendments	—			696
Special termination benefits	98			334
Plan settlements	(7,439		)	(7,991		)
Plan curtailments	—			(6,565		)
Benefit obligation, end of year	$	941,094		$	1,005,368
Change in plans' assets:
Fair value of plans' assets, beginning of year	$	821,675		$	827,337
Actual return on plans' assets	56,818			50,637
Company contributions	11,960			15,876
Participant contributions	8			6
Plan settlements	(7,439		)	(7,991		)
Benefits and expenses paid	(70,257		)	(45,074		)
Currency translation adjustments	(4,130		)	(19,116		)
Fair value of plans' assets, end of year	$	808,635		$	821,675
Funded status of plans	$	(132,459	)	$	(183,693	)
Amounts recognized in the balance sheet consist of:
Long-term prepaid benefit	$	17,208		$	8,941
Short-term accrued benefit obligation	(5,713		)	(10,037		)
Accrued pension benefits	(143,954		)	(182,597		)
Net amount recognized	$	(132,459	)	$	(183,693	)

The pre-tax amounts related to our defined benefit pension plans recognized in accumulated other comprehensive (loss) income were as follows at June 30:



(in thousands)	2017		2016
Unrecognized net actuarial losses	$	246,428	$	272,802
Unrecognized net prior service credits	580		155
Unrecognized transition obligations	622		740
Total	$	247,630	$	273,697

Prepaid pension benefits are included in other long-term assets. The assets of our U.S. and international defined benefit pension plans consist principally of capital stocks, corporate bonds and government securities.

To the best of our knowledge and belief, the asset portfolios of our defined benefit pension plans do not contain our capital stock. We do not issue insurance contracts to cover future annual benefits of defined benefit pension plan participants. Transactions between us and our defined benefit pension plans include the reimbursement of plan expenditures incurred by us on behalf of the plans. To the best of our knowledge and belief, the reimbursement of cost is permissible under current ERISA rules or local government law. The accumulated benefit obligation for all defined benefit pension plans was $940.9 million and $1,003.5 million as of June 30, 2017 and 2016, respectively.

Included in the above information are plans with accumulated benefit obligations exceeding the fair value of plan assets as of June 30 as follows:



(in thousands)	2017		2016
Projected benefit obligation	$	156,816	$	877,146
Accumulated benefit obligation	156,590		875,233
Fair value of plan assets	7,083		684,512

The components of net periodic pension income include the following as of June 30:



(in thousands)	2017			2016			2015
Service cost	$	2,908		$	4,640		$	5,474
Interest cost	31,113			37,726			39,007
Expected return on plans' assets	(58,781		)	(58,523		)	(59,698		)
Amortization of transition obligation	89			80			78
Amortization of prior service cost	(452		)	(417		)	(361		)
Special termination benefit charge	98			334			459
Curtailment loss	—			—			358
Settlement loss	379			227			261
Recognition of actuarial losses	8,356			7,286			3,671
Net periodic pension income	$	(16,290	)	$	(8,647	)	$	(10,751	)

As of June 30, 2017, the projected benefit payments, including future service accruals for these plans for 2018 through 2022, are $47.5 million, $49.0 million, $50.0 million, $51.5 million and $52.0 million, respectively, and $277.8 million in 2023 through 2027.

The amounts of accumulated other comprehensive loss expected to be recognized in net periodic pension cost during 2018 related to net actuarial losses and transition obligations are $6.8 million and $0.1 million, respectively. The amount of accumulated other comprehensive income expected to be recognized in net periodic pension cost during 2018 related to prior service credit is $0.2 million.

We expect to contribute approximately $7.9 million to our pension plans in 2018.

Other Postretirement Benefit Plans

The funded status of our other postretirement benefit plans and the related amounts recognized in the consolidated balance sheets were as follows:



(in thousands)	2017			2016
Change in benefit obligation:
Benefit obligation, beginning of year	$	20,542		$	21,205
Interest cost	673			840
Actuarial losses	(747		)	722
Benefits paid	(2,308		)	(2,225		)
Benefit obligation, end of year	$	18,160		$	20,542
Funded status of plan	$	(18,160	)	$	(20,542	)
Amounts recognized in the balance sheet consist of:
Short-term accrued benefit obligation	$	(1,254	)	$	(1,666	)
Accrued postretirement benefits	(16,906		)	(18,876		)
Net amount recognized	$	(18,160	)	$	(20,542	)

The pre-tax amounts related to our other postretirement benefit plans which were recognized in accumulated other comprehensive (loss) income were as follows at June 30:



(in thousands)	2017			2016
Unrecognized net actuarial losses	$	5,266		$	6,368
Unrecognized net prior service credits	(128		)	(150		)
Total	$	5,138		$	6,218

The components of net periodic other postretirement benefit cost include the following for the years ended June 30:



(in thousands)	2017			2016			2015
Service cost	$	—		$	—		$	45
Interest cost	673			840			934
Amortization of prior service credit	(22		)	(22		)	(59		)
Recognition of actuarial loss	355			324			492
Curtailment gain	—			—			(221		)
Net periodic other postretirement benefit cost	$	1,006		$	1,142		$	1,191

As of June 30, 2017, the projected benefit payments, including future service accruals for our other postretirement benefit plans for 2018 through 2022, are $1.9 million, $1.8 million, $1.7 million, $1.6 million and $1.5 million, respectively, and $6.2 million in 2023 through 2027.

The amounts of accumulated other comprehensive loss expected to be recognized in net periodic pension cost during 2018 related to net actuarial losses are $0.3 million. The amount of accumulated other comprehensive income expected to be recognized in net periodic pension cost during 2018 related to prior service credit is less than $0.1 million.

We expect to contribute approximately $1.9 million to our postretirement benefit plans in 2018.

Assumptions

The significant actuarial assumptions used to determine the present value of net benefit obligations for our defined benefit pension plans and other postretirement benefit plans were as follows:



	2017		2016	2015
Discount Rate:
U.S. plans	3.3-3.9%		2.4-3.7%	3.2-4.5%
International plans	2.0-3.3%		0.9-3.2%	2.3-3.8%
Rates of future salary increases:
U.S. plans	4.0	%	3.0-4.0%	3.0-4.0%
International plans	2.5-3.0%		2.5-3.0%	2.5-3.0%

The significant assumptions used to determine the net periodic (income) cost for our pension and other postretirement benefit plans were as follows:



	2017		2016		2015
Discount Rate:
U.S. plans	2.4-3.7%		3.2-4.5%		4.4	%
International plans	0.9-3.2%		2.3-3.8%		2.9-4.3%
Rates of future salary increases:
U.S. plans	3.0-4.0%		3.0-4.0%		3.0-5.0%
International plans	2.5-3.0%		2.5-3.0%		2.5-3.0%
Rate of return on plans assets:
U.S. plans	7.5	%	7.5	%	7.5	%
International plans	5.3-5.5%		5.3-5.5%		5.0-6.0%

The rates of return on plan assets are based on historical performance, as well as future expected returns by asset class considering macroeconomic conditions, current portfolio mix, long-term investment strategy and other available relevant information.

The annual assumed rate of increase in the per capita cost of covered benefits (the health care cost trend rate) for our postretirement benefit plans was as follows:



	2017		2016		2015
Health care costs trend rate assumed for next year	8.0	%	8.5	%	7.3	%
Rate to which the cost trend rate gradually declines	5.0	%	5.0	%	5.0	%
Year that the rate reaches the rate at which it is assumed to remain	2027		2027		2024

A change of one percentage point in the assumed health care cost trend rates would have the following effects on the total service and interest cost components of our other postretirement cost and other postretirement benefit obligation at June 30, 2017:



(in thousands)	1% Increase		1% Decrease
Effect on total service and interest cost components	$	30	$	(27	)
Effect on other postretirement obligation	735		(655		)

Plan Assets

The primary objective of certain of our pension plans' investment policies is to ensure that sufficient assets are available to provide the benefit obligations at the time the obligations come due. The overall investment strategy for the defined benefit pension plans' assets combine considerations of preservation of principal and moderate risk-taking. The assumption of an acceptable level of risk is warranted in order to achieve satisfactory results consistent with the long-term objectives of the portfolio. Fixed income securities comprise a significant portion of the portfolio due to their plan-liability-matching characteristics and to address the plans' cash flow requirements. Additionally, diversification of investments within each asset class is utilized to further reduce the impact of losses in single investments.

Investment management practices must comply with ERISA and all applicable regulations and rulings thereof. The use of derivative instruments is permitted where appropriate and necessary for achieving overall investment policy objectives. Currently, the use of derivative instruments is not significant when compared to the overall investment portfolio.

The Company utilizes a liability driven investment strategy (LDI) for the assets of its U.S. defined benefit pension plans in order to reduce the volatility of the funded status of these plans and to meet the obligations at an acceptable cost over the long term. This LDI strategy entails modifying the asset allocation and duration of the assets of the plans to more closely match the liability profile of these plans. The asset reallocation involves increasing the fixed income allocation, reducing the equity component and adding alternative investments. Longer duration interest rate swaps have been utilized periodically in order to increase the overall duration of the asset portfolio to more closely match the liabilities.

Our defined benefit pension plans’ asset allocations as of June 30, 2017 and 2016 and target allocations for 2018, by asset class, were as follows:



	2017		2016		Target %
Equity	27	%	23	%	22.5	%
Fixed Income	63	%	67	%	70.0	%
Other	10	%	10	%	7.5	%

The following sections describe the valuation methodologies used by the trustee to measure the fair value of the defined benefit pension plan assets, including an indication of the level in the fair value hierarchy in which each type of asset is generally classified (see Note 5 for the definition of fair value and a description of the fair value hierarchy).

Corporate fixed income securities Investments in corporate fixed income securities consist of corporate debt and asset backed securities. These investments are classified as level two and are valued using independent observable market inputs such as the treasury curve, swap curve and yield curve.

Common stock Common stocks are classified as level one and are valued at their quoted market price.

Government securities Investments in government securities consist of fixed income securities such as U.S. government and agency obligations and foreign government bonds and asset and mortgage backed securities such as obligations issued by government sponsored organizations. These investments are classified as level two and are valued using independent observable market inputs such as the treasury curve, credit spreads and interest rates.

Other fixed income securities Investments in other fixed income securities are classified as level two and valued based on observable market data.

Other Other investments consist primarily of a hedge fund, in addition to state and local obligations and short term investments including cash, corporate notes, and various short term debt instruments which can be redeemed within a nominal redemption notice period. These investments are primarily classified as level two and are valued using independent observable market inputs.

The fair value methods described may not be reflective of future fair values. Additionally, while the Company believes the valuation methods used by the plans’ trustee are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in different fair value measurement at the reporting date.

The following table presents the fair value of the benefit plan assets by asset category as of June 30, 2017:



(in thousands)	Level 1		Level 2		Level 3		NAV⁽³⁾		Total
Common / collective trusts ⁽³⁾:
Value funds	$	—	$	—	$	—	$	76,186	$	76,186
Growth funds	—		—		—		43,880		43,880
Balanced funds	—		—		—		12,421		12,421
Corporate fixed income securities	—		365,723		—		—		365,723
Common stock	85,138		—		—		—		85,138
Government securities:
U.S. government securities	—		72,817		—		—		72,817
Foreign government securities	—		45,359		—		—		45,359
Other fixed income securities	—		25,761		—		—		25,761
Other	3,313		78,037		—		—		81,350
Total investments	$	88,451	$	587,697	$	—	$	132,487	$	808,635

The following table presents the fair value of the benefit plan assets by asset category as of June 30, 2016:



(in thousands)	Level 1		Level 2		Level 3		NAV⁽³⁾		Total
Common / collective trusts ⁽³⁾:
Value funds	$	—	$	—	$	—	$	68,731	$	68,731
Growth funds	—		—		—		38,126		38,126
Balanced funds	—		—		—		8,581		8,581
Corporate fixed income securities	—		395,102		—		—		395,102
Common stock	74,163		—		—		—		74,163
Government securities:
U.S. government securities	—		79,275		—		—		79,275
Foreign government securities	—		43,729		—		—		43,729
Other fixed income securities	—		31,503		—		—		31,503
Other	3,029		79,436		—		—		82,465
Total investments	$	77,192	$	629,045	$	—	115,438		$	821,675

⁽³⁾Investments in common / collective trusts invest primarily in publicly traded securities and are valued using net asset value (NAV) of units of a bank collective trust. Therefore, these amounts have not been classified in the fair value hierarchy and are presented in the tables to reconcile the fair value hierarchy to the total fair value of plan assets.

Defined Contribution Plans

We sponsor several defined contribution retirement plans. Costs for defined contribution plans were $15.8 million, $17.2 million and $23.1 million in 2017, 2016 and 2015, respectively.