Financial Section Part II

As calculated by OPM, the recognition of military service credit effectively transferred $27 billion in obligations from U.S. taxpayers to our ratepayers. This assumption of funding responsibility by the Postal Service changed our CSRS funding status at the end of 2002 from being overfunded to being underfunded. Use of dynamic assumptions for the valuation also increased our biweekly payroll contribution for CSRS employees’ retirement from 7.0% of basic pay to 17.4%.

In addition to the 17.4% employer contribution, we make annual payments on the excess of the actuarial present value of future benefits over the actuarial present value of plan assets, future plan contributions, earnings, and other factors. This amount is referred to as the “supplemental liability” and is calculated by OPM each year. See Note 10, Retirement Programs in Notes to the Financial Statements for additional information.

Use of P.L.108-18 “Savings”

P.L.108-18 identifies as “savings” the difference between the contributions we would have made to the CSRDF had the legislation not been enacted and the contributions we now make under the law.

In 2004, as required by law, we used “savings” of $2.7 billion to reduce our outstanding debt to the U.S. Treasury. In addition to the required debt reduction we further reduced our debt by an additional $2.8 billion, for a total debt reduction of $5.5 billion. In 2005 we paid our remaining debt of $1.8 billion, and used the remainder of the “savings” to offset operational expenses and hold postage rates steady.

Pending future legislation, any “savings” after 2005 must be placed in escrow. To partially fund the 2006 escrow requirement, we raised postage rates an average of 5.4% across all rate classifications on January 8, 2006. On September 30, 2006, we placed $2,958 million into a restricted cash account.

Health Benefits

We participate in the Federal Employees Health Benefits Program (FEHBP) which is administered by OPM. Eligible postal employees with at least five consecutive years participation in the FEHBP immediately preceding retirement are entitled to continue FEHBP coverage after retirement. We account for our employee and retiree health benefit costs as an expense in the period our contribution is due and payable to FEHBP using multiemployer plan accounting rules in accordance with Financial Accounting Standards Board Statement 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions.

The drivers of our active employee health care costs are the number of employees electing coverage and the premium costs of the plans they select. Premiums for each plan participating in FEHBP are determined annually by OPM. In 2006, health benefit expenses for active employees were $5,345 million, an increase of $245 million over 2005. This was 7.4% of our total expenses. The 2005 expense of $5,100 million was 7.4% of our total expenses and increased by $255 million over 2004 when employee health benefits were 7.3% of our total expense.

Retiree health benefit costs, which are 2.3% of our total expenses, were $1,637 million in 2006 up from $1,495 million in 2005 and $1,313 million in 2004. This cost has risen steadily over the last three years, and has more than doubled since 2000, driven by increases in FEHBP premium costs, an increasing number of annuitants enrolled in the plan, and the declining number of annuitants for whom a portion of the premium cost is allocable to Post Office Department service. The combined effects of these drivers increased retiree health benefit costs by 9.5% or $142 million in 2006 and 13.9% or $182 million in 2005.

In September 2006, OPM announced a 1.8% average increase in health benefit premiums, to take effect in January 2007, following a 6.6% increase in January 2006. A major factor in the lower health benefit premiums is a one time change by OPM which released a health benefits fund surplus to lower the cost. As of the end of 2006, there were approximately 448,000 Postal Service annuitants and survivors compared to 444,000 in 2005 and 438,000 in 2004. We estimate that more than 200,000 of our current employees will be eligible for retirement by 2008.

As an independent establishment of the U.S. government, our participation in FEHBP requires us to account for this expense using multi-employer plan accounting rules. If we were not a participant in the federal government plan, we would be required to record and disclose our obligation for future health benefit obligations. Because there are several areas of judgment involved in calculating this obligation, estimates can vary widely based on the assumptions used. Based on September 30, 2006, data, we estimate, that if we sponsored our own plan at similar costs and benefits to the federal plans, the 2006 present value of future premium payments to be between $50 billion and $58 billion. Based on September 30, 2005, data, we estimated the 2005 value of future payments to be between $50 billion and $59 billion. In both cases, the range in the estimate exists only because long-term medical inflation assumptions differed by 1%.

Workers’ Compensation

Our employees are covered by the Federal Employees’ Compensation Act, administered by the Department of Labor’s Office of Workers’ Compensation Programs (OWCP) which makes all decisions regarding injured workers’ eligibility for benefits. However, we pay all workers’ compensation claims from postal funds.

We record as a liability the present value of all future payments we expect to make to those employees receiving workers’ compensation. At the end of 2006, we estimate our total liability for future workers’ compensation costs at $7,863 million, an increase of $342 million or 4.5% from 2005. In 2005 our liability declined $58 million or 0.8% from 2004.

In 2006 we experienced a 2.3% decrease in the number of paid medical claims and a 1.7% decrease in the number of paid compensation claims. Although the number of paid claims decreased, the actual cost of claims increased $45 million over 2005. A factor in this increase was the 3.5% January 2006 COLA which raised the payments to all compensation