Financial Section Part II

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 2007, we estimate our total liability for future workers’ compensation costs at $7,771 million, a decrease of $92 million or 1.2% from 2006. In 2006 our liability increased $342 million or 4.5% from 2005.

In 2007, we experienced a 4.6% decrease in the number of paid medical claims and a 0.2% decrease in the number of paid compensation claims. Although the number of paid claims decreased, the actual cost of claims increased $41 million over 2006. A factor in this increase was the 2.4% March 2007 COLA, which raised the payments to all compensation claimants on the rolls.

As discussed in detail in Note 11, Workers’ compensation, in the Notes to the Financial Statements, we utilized a calculation performed by an independent actuary to estimate our liability for 2007. This calculation combined two generally accepted actuarial valuation techniques: the paid loss development method and the incremental frequency/severity method. Both of these methods were used to separately estimate a liability for compensation and medical claims. Adoption of this new approach required that we reconsider all the assumptions that go into estimating liability for both claim types. We changed a number of assumption changes that were individually insignificant, but that were, in our judgment, necessary to produce the most realistic estimate in the new model.

We also engaged a separate independent actuary to evaluate the discount and inflation rates used in estimating our liability and made changes to these rates in 2007 as well. As discussed in more detail in Note 11, Workers’ compensation, in the Notes to the Financial Statements, the actuarial model used in 2007 uses separate inflation and discount rates for compensation and medical claims, while the model used in 2006 and prior years used net discount rates for both claim types.

The net effect of the adoption of new actuarial valuation techniques and new inflation and discount rates was a reduction in 2007 expenses of $685 million.

In 2006, the number of paid medical claims and the number of paid compensation claims decreased 2.3% and 1.7% respectively. Although the number of paid claims decreased, the actual cost of claims increased $45 million over 2005, again influenced by the annual March COLA, which raised the payments to all compensation claimants on the rolls 3.5%. The $45 million increase in the cost of claims also was the driver behind the $342 million increase in our total liability.

The lower number of claims in 2007 and 2006 is a result of our efforts to prevent workplace injuries and our joint initiative with OWCP to increase the number of injured employees returned to work. In the final year of a five-year program, we successfully met and exceeded our goal to outplace 1,000 employees from workers’ compensation rolls. There have been a total of 1,029 successful outplacements and rehabilitations. This program has long-term effects on the cost of workers’ compensation by reducing the base costs.

Transportation Expenses

Transportation expenses for 2007 were $6,502 million, an increase of $457 million, or 7.6%, compared to 2006. Transportation costs are largely made up of air and highway transportation.

Air Transportation

Air transportation expenses for 2007 were $2,990 million, an increase of $219 million, or 7.9% compared to the same period last year. The increase was driven by a growth in mail volume on our cargo carriers and the expansion of peak season operations, which provided improved service to our customers. Additional contributing factors were increases in contract rates for the offshore networks and an increase in fuel expenditures. With the five percent growth in international volume, we also saw a corresponding increase in international air expense compared to 2006.

Air transportation expenses for 2006 were $2,771 million, an increase of $326 million, or 13.3% from 2005. In 2006 the increase was due to increased fuel charges and increased mail volume on our cargo carriers.

Highway Transportation

Highway transportation expenses for 2007 were $3,150 million, an increase of $173 million, or 5.8% over 2006. This was driven by an increase in the number of miles driven, contractual rate increases for the contract drivers, and delivery growth. The increase in fuel prices was somewhat neutralized through leveraging our buying power to obtain favorable pricing by consolidating fueling points and bulk purchasing.

In 2006, our highway transportation expenses were $2,977 million, an increase of $319 million, or 12.0% over 2005. These increases were primarily driven by diesel fuel prices and contractual rate increases.

Other Transportation

Other transportation expenses for 2007 were $362 million, an increase of $65 million, or 21.9% mainly driven by international terminal dues settlements to foreign postal administrations and Expedited Mail delivery transactions compared to 2006. Terminal dues settlements are the fees we pay to foreign postal administrations for the outbound international mail that they deliver for us.

In 2006, other transportation expenses were $297 million, a decrease of $37 million, or 11.1%, primarily as a result of our decision to reduce the use of rail to transport mail and shift this mail onto highway routes.