Retiree Health Benefits

We are required to pay a portion of the health insurance premiums of those retirees and their survivors who participate in the Federal Employees Health Benefits Program (FEHBP). We account for our participation in FEHBP as a participant in a multi-employer plan arrangement in accordance with FAS 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. Therefore, the costs of retiree health benefits are expensed as we incur them. See note 4 for additional information.

Workers' Compensation Costs

We are self-insured for workers' compensation costs under a program administered by the Department of Labor (DOL). We record these costs, which include the employees' medical expenses and payment for continuation of wages, as an operating expense.

Our liability represents the estimated present value of the total amounts we expect to pay in the future for postal workers injured through the end of 2004. The estimate of the total costs of a claim is based upon the severity of the injury, the age of the injured employee, the assumed life expectancy of the employee, the trend of our experience with such an injury and other factors. In our calculation of present value, a net discount rate of -0.8% for medical expenses and 3.3% for compensation claims is used. During 2004 we changed these discount rates in order to more accurately reflect our liability. See note 3 for additional information.

Emergency Preparedness Appropriations

Emergency preparedness appropriations are the funds received from the federal government to help pay the costs to keep the mail, postal employees and postal customers safe. Upon receipt of the funds, we established a liability. In 2002 and 2003 we recognized these funds as non-operating revenue to the extent of the qualifying non-operating expenditure. Beginning in 2004 we are recognizing these funds as operating revenue to the extent they offset operating expenses. Appropriations utilized to purchase capital equipment will be offset against depreciation expense over the life of the equipment. See note 11 for additional information.

Reclassifications

Certain comparative prior year amounts in the financial statements and accompanying notes have been reclassified to conform to the current year presentation. These reclassifications had no effect on previously reported operating income and net income.

Note 3 - workers' compensation

At the end of 2004, we estimate our total liability for future workers' compensation costs at $7,579 million. At the end of 2003 this liability was $7,236 million. The payout period for this liability will, for some claimants currently on the rolls, be for the rest of their lives. The liability is sensitive to changes in inflation and discount rates. An increase of 1% in the assumptions would decrease our estimate of the liability by approximately $650 million. A decrease of 1% would increase our estimate of the liability by approximately $790 million.

In 2004, we recorded $1,239 million in workers' compensation expense, compared to the $1,473 million we recorded in 2003 and the $1,524 million we recorded in 2002.

In 2004, we changed the net discount rates used to determine the present value of estimated future workers' compensation payments, in consultation with an independent actuary. Our net discount rate is the estimated difference between what we expect to earn on investments compared to what we assume the inflation rate will be for medical costs and wage increases. Our net discount rate of -0.8% for medical claims means that our assumptions show that the average rate of inflation for medical claims (5.5%) will exceed our investment returns (4.7%) by 0.8% per year over the expected life of the medical claims. Conversely we believe that our assumed investment returns (5.5%) will exceed the rate of inflation on the consumer wages index (2.2%) by 3.3% over the expected life of the compensation claims.

The reduction in the medical claims net discount rate from 1.4% to -0.8% resulted in an increase in the medical claims liability and expense of $362 million. The compensation claims net discount rate was increased from 3.0% to 3.3%, thereby reducing the liability and expense by $148 million. The combined changes increased the total workers' compensation liability and expense by $214 million. The effect of the adoption of these changes is accounted for as a change in accounting estimate.

In addition to the cost of workers' compensation claims, OWCP charges us an administrative fee for processing claims. In 2004, the administrative fee was $44 million, compared to $45 million in 2003 and $37 million in 2002.

Note 4 - health benefit programs

Career employees of the Postal Service are covered by the U.S. government health plan, the Federal Employees Health Benefits Program (FEHBP). The Office of Personnel Management administers the program and allocates the cost of the program to the various participating employers. Our