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Report of the Treasurer of the National Academy of Sciences Notes to Financial Statements December 31, 2010 and 2009 (1) ORGANIZATION AND RELATED ENTITIES (a) National Academy of Sciences The National Academy of Sciences (NAS) was formed under a charter that was passed as an Act of Incorporation by the United States Congress and signed into law on March 3, 1863. NAS operates as a private cooperative society of distinguished scholars engaged in scientific or engineering research, dedicated to the furtherance of science and its use for the general welfare. (b) National Research Council Most of the activities undertaken by NAS are carried out through the divisions and boards of the National Research Council (NRC). The NRC draws on a wide cross section of the nation’s leading scientists and engineers for advisory services to government agencies and Congress. To respond effectively to both the disciplinary concerns of the research community and the complex interdisciplinary problems facing American society, NRC is organized into the following five major divisions responsible for most study activities: Behavioral and Social Sciences and Education Earth and Life Studies Engineering and Physical Sciences Policy and Global Affairs Transportation Research Board NRC activities are under the control of the NAS governance structure, and therefore are included in the NAS financial statements. (c) Institute of Medicine The Institute of Medicine (IOM), established in 1970, conducts studies of policy issues related to health and medicine. IOM issues position statements on these policies, cooperates with the major scientific and professional societies in the field, identifies qualified individuals to serve on study groups in other organizational units, and disseminates information to the public and the relevant professions. IOM was established as a separate membership organization within NAS. The financial activities and results of IOM are included in the NAS financial statements. (d) National Academy of Engineering The National Academy of Engineering (NAE) was established in 1964 under the charter of NAS as a related parallel organization, autonomous in its governance, administration, and the selection of its members. NAE shares with NAS the responsibility for advising the federal government on scientific issues. The NAE conducts independent program activities and activities through the NRC. The results of both of these activities are included in the NAS financial statements. (e) National Academy of Engineering Fund The National Academy of Engineering Fund (NAEF) is a separately incorporated not-for-profit organization established and controlled by NAE to raise funds to support its goals. The financial activities and results of NAEF are not included in the NAS financial statements. (f) The National Academies’ Corporation The National Academies’ Corporation (TNAC) was separately incorporated in 1986 as a not-for-profit corporation for the purpose of constructing and maintaining a study and conference facility. This facility, the Arnold and Mabel Beckman Center, located in Irvine, California, operates to expand and support the general activities of NAS, NRC, IOM, and NAE. TNAC is controlled by NAS and NAEF. The financial position and results of TNAC are not consolidated in the NAS financial statements. NAS manages the operations of the Beckman Center. There were no contributions from TNAC to the NRC during 2010 and 2009 to support operations of the Beckman Center. TNAC contributed $5,000 and $4,000 to the NRC for the years ending December 31, 2010 and 2009, respectively, to be spent on programs conducted in whole or in part at the Beckman Center. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Basis of Accounting Net assets, revenues, gains, and losses are classified based on the existence or absence of donor-imposed restrictions. Accordingly, net assets of NAS are classified and reported as follows:
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Report of the Treasurer of the National Academy of Sciences Permanently restricted – Net assets subject to donor-imposed stipulations that they be maintained in perpetuity by NAS. Generally, the donors of these assets permit NAS to use all or part of the income earned on related investments for general or specific purposes. Temporarily restricted – Net assets subject to donor-imposed stipulations that may or will be met either by actions of NAS and/or the passage of time. When a donor restriction expires, temporarily restricted net assets are reclassified to unrestricted net assets. Unrestricted – Net assets arising from exchange transactions and contributions not subject to donor-imposed stipulations. (b) Cash Equivalents NAS reports liquid, temporary investments purchased with original maturities of three months or less as cash equivalents. (c) Investments Investments are stated at fair value. Changes in the fair value of investments are reported within investment income in the statements of activities. Certain investments are pooled for long-term investment purposes. Investments in the pool are administered as an open-end investment trust, with shares of the pool funds expressed in terms of participating capital units (PCUs). PCU values are used to determine equity in the allocation of investment income among funds in the pool whenever additional funds are contributed or withdrawn. (d) Contributions Contributions, including unconditional promises to give, are recognized as revenues in the period received. Conditional promises to give are not recognized until all conditions on which receipt depends are substantially met. Gifts of land, buildings, or equipment are reported as unrestricted net assets unless explicit donor stipulations specify how the donated assets must be used. Temporary restrictions on gifts that must be used to acquire long-lived assets are released in the period in which the assets are acquired or placed in service. Allowances are recorded for estimated uncollectible contributions based upon management’s judgment and analysis of the credit worthiness of the donor, past collection experience, and other relevant factors. Contributions to be received after one year are discounted at an appropriate rate commensurate with risks involved. Amortization of the discount is recorded as additional revenue and is used in accordance with donor-imposed restrictions, if any, on the contributions. NAS performs certain fundraising activities on behalf of NAEF. NAS collected a total of $4.1 million and $5.3 million in 2010 and 2009, respectively, on behalf of NAEF. NAS disbursed $4.1 million and $5.2 million to NAEF from these collected amounts in 2010 and 2009, respectively. Amounts collected but not yet remitted to NAEF are reported as assets and liabilities in the NAS financial statements. (e) Contracts and Grants The majority of NAS activities are performed under cost-reimbursable contracts with the U.S. government. For the years ended December 31, 2010 and 2009, the Department of Transportation provided 45% and 44%, respectively, of NAS government grant and contract revenue. NAS records federal contracts as exchange transactions, recognizing revenue as recoverable costs are incurred. Revenues from nonfederal grants qualifying as contributions are recorded by NAS upon notification of the grant award. Such grants are classified as temporarily restricted net assets when use of the grant funds is limited to specific areas of study or is designated for use in future periods. (f) Deferred Revenue For both federal and nonfederal grants and contracts that are determined to be exchange transactions, revenue is recognized as the related costs are incurred. Funds received in advance of being earned for these grants are recorded as deferred revenue in the statements of financial position. (g) Inventories Inventories are stated at the lower of cost or net realizable value and include both work in-process and finished goods related to publication activities. The majority of NAS publication inventories and supplies reside with an NAS unit, the National Academy Press (NAP). NAP uses the full absorption costing methodology in pricing finished products. This methodology includes direct printing and related indirect costs. Inventories are included in other current assets in the statements of financial position.
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Report of the Treasurer of the National Academy of Sciences (h) Property and Equipment Depreciation of NAS buildings and equipment is computed on a straight-line basis using the following lives: Asset Class Depreciable Lives Buildings 40 years Buildings and leasehold improvements Lesser of the remaining life of the building or improvement Furniture and equipment 4 to 10 years Capitalized software 3 to 10 years The Einstein Memorial sculpture is valued at cost and is not depreciated. Construction-in-progress is not depreciated until the related assets are placed in service. Capitalized software is amortized over its depreciable life when it is ready for its intended use and placed in service. (i) Split-Interest Agreements Charitable gift annuity agreements are classified as other assets in the statements of financial position. Periodically, NAS pays a fixed amount of the assets to the beneficiary designated by the donor. Upon termination of an annuity, the remainder interest in the assets is available for use by NAS as restricted or unrestricted assets in accordance with the donor’s designation. At December 31, 2010 and 2009, NAS had charitable gift annuity assets of $2.1 million and $2.4 million, respectively. NAS has recorded a liability of $1.3 million and $1.4 million at December 31, 2010 and 2009, respectively, representing the present value of estimated future cash payments to annuitants based on the annuitant’s life expectancy. (j) Income Taxes NAS is exempt from federal income taxes under Section 501(c)(3) of the Internal Revenue Code, except for unrelated business income. NAS recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. NAS does not believe its financial statements include any uncertain tax positions. (k) Recently Adopted Accounting Pronouncements Effective December 31, 2010, NAS applied the guidance in FASB Accounting Standards Update 2010-06, Fair Value Measurements and Disclosures – Improving Disclosures about Fair Value Measurements, to its financial assets and liabilities disclosed at fair value. This guidance requires fair value measurement disclosures for each class of assets and liabilities and enhanced disclosures for transfers among the fair value hierarchy. Effective December 31, 2009, NAS applied the guidance in FASB Accounting Standards Update 2009-12, Fair Value Measurements and Disclosures – Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent), to its investments including hedge funds and private placement equity investments. This guidance permits, as a practical expedient, the fair value of investments within its scope to be estimated using net asset value (NAV) per share or its equivalent. Effective December 31, 2009, NAS applied the guidance in FASB ASC Topic 855, Subsequent Events (FASB ASC 855), which establishes general standards of accounting for and disclosure of events that occur after the statement of financial position date but before the financial statements are issued. FASB ASC 855 also requires disclosure of the date through which an entity has evaluated subsequent events. (l) Use of Estimates The preparation of these financial statements in conformity with U.S. generally accepted accounting principles requires management to make certain estimates and assumptions. These estimates and assumptions may affect the reported amounts of assets and liabilities and disclosures in the financial statements. Actual results could differ from those estimates. (m) Reclassifications Certain amounts from the prior year have been reclassified to conform to the current year presentation. (3) INVESTMENTS Investments, which are reported at fair value (except as noted), consisted of the following as of December 31, 2010 and 2009 (dollars in thousands): 2010 2009 Short-term investments: Cash equivalents $ 12,503 $ 8,990 Bonds and notes 31,666 29,561 Equity securities 12,608 10,562 Total short-term investments $ 56,777 $ 49,113
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Report of the Treasurer of the National Academy of Sciences 2010 2009 Long-term investments: Investment pool, including endowment assets: Cash equivalents $ 6,381 $ 7,699 Bonds and notes 38,775 39,998 Equity securities 263,900 239,112 Hedge funds 55,303 45,536 Private equity 19,570 12,035 383,929 344,380 Other long-term investments: Cash equivalents 3,004 1,291 Bonds and notes 16,463 13,583 Equity securities 19,666 16,909 39,133 31,783 Total long-term investments $ 423,062 $ 376,163 Vanguard equity funds comprised approximately $97.0 million and $85.5 million of the total equity securities funds at December 31, 2010 and 2009, respectively. NAS holds alternative investments, comprised of private equity securities and hedge funds, in its long-term investment pool. At December 31, 2010 and 2009, these funds had a fair value of approximately $74.9 million and $57.6 million, respectively. The unrealized gain on the hedge funds was approximately $4.1 million and $2.6 million for the years ended December 31, 2010 and 2009, respectively, and is included as a component of investment income in the accompanying statements of activities. Private equity investments are comprised of limited partnership interests. NAS had remaining commitments at December 31, 2010 and 2009 to provide approximately $3.6 million and $5.1 million, respectively, to these partnerships. TNAC, a related entity, invests certain of its assets in the NAS long-term investment pool. TNAC investments participate in the investment pool experience proportionally with all other funds in this pool. The NAS obligation to TNAC for these funds held in trust, which totaled approximately $9.9 million and $8.8 million as of December 31, 2010 and 2009, respectively, is reported as funds held on behalf of others in the statements of financial position. Investment income is reported net of investment expenses of approximately $446,000 and $691,000 for the years ended December 31, 2010 and 2009, respectively, and is comprised of the following (dollars in thousands): 2010 2009 Interest and dividends income $ 9,610 $ 8,379 Net gain on investments 49,231 70,998 Total investment income $ 58,841 $ 79,377 (4) FAIR VALUE MEASUREMENTS Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC Topic 820 establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value: Level 1: Quoted prices in active markets for identical assets or liabilities. Level 2: Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the asset or liabilities. The following discussion describes the valuation methodologies used for financial assets measured at fair value. The techniques utilized in estimating the fair values are affected by the assumptions used, including discount rates and estimates of the amount and timing of future cash flows. Care should be exercised in deriving conclusions about NAS’ business, its value or financial position based on the fair value information of financial assets presented below. Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial asset, including estimates of timing, amount of expected future cash flows and the credit standing of the issuer. In some cases, the fair value estimates cannot be substantiated by comparison to independent markets. In addition, the disclosed fair value may not be realized in the immediate settlement of the financial asset. Furthermore, the disclosed fair values do not reflect any premium or discount that could result from offering for sale at one time an entire holding of a particular financial asset. Potential taxes and other
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Report of the Treasurer of the National Academy of Sciences expenses that would be incurred in an actual sale or settlement are not reflected in amounts disclosed. The following methods and assumptions were used to estimate the fair value of each class of financial instruments: The carrying value of cash equivalents such as money market funds approximates the fair value because of the short maturity of these investments. These amounts are disclosed in Level 1. NAS’ fixed maturity investments (bonds and notes), other than U.S. Treasury securities, generally do not trade on a daily basis. The fair value estimates of such debt securities are based on prices provided by NAS’ investment managers and custodian bank. Both the investment managers and the custodian bank use a variety of pricing sources to determine market valuations. Each designate specific pricing services or indexes for each sector of the market based upon the provider’s expertise. NAS’ debt securities portfolio is highly liquid, which allows for a high percentage of the portfolio to be priced through pricing services. Accordingly, the estimates of fair value for such debt securities are included in Level 2 inputs. The estimated values of U.S. Treasury securities are based on actively traded market prices and are accordingly included in the bonds and notes amount in Level 1. Fair values of exchange-traded equity securities have been determined by NAS from observable market quotations on major trade exchanges. Accordingly, such equity securities are disclosed in Level 1. NAS also invests in debt and equity mutual funds. For purposes of the fair value disclosure, mutual funds are presented based on the class of the underlying investment holdings. The fair values of such mutual funds are based on observable market information from active markets. Accordingly, the estimates of fair value for such mutual funds are included in Level 1. Fair value of alternative investments including private equity securities and hedge funds is based on the alternative investment fund managers’ NAV. Valuations provided by alternative investment fund managers include estimates, appraisals, assumptions and methods that are reviewed by management. When necessary, NAS adjusts NAV for contributions, distributions, or general market conditions subsequent to the latest NAV valuation date when calculating fair value. Since the most significant valuation inputs are not observable in the marketplace, the alternative investment valuations are disclosed in Level 2 or Level 3. The distinction is that those funds which are available for redemption in the near term at NAV are included in Level 2. Funds on deposit with trustee are held in U.S. Treasury securities or funds of U.S. Treasury securities and therefore included in Level 1. Charitable gift annuity investments and deferred compensation investments are held in debt and equity mutual funds along with some U.S. Treasury securities, all of which are included in Level 1. The deferred compensation obligation to employees is equal to the fair value of the investments held and is disclosed in the same levels as the investment assets. NAS has interest rate swap agreements covering the variable-rate bonds payable. The fair value of the swaps are determined using pricing models based on observable market data such as prices of instruments with similar maturities and characteristics, interest rate yield curves, and measures of interest rate volatility. The value was determined after considering the potential impact of collateralization and netting agreements, adjusted to reflect nonperformance risk of both the counterparty and NAS. Accordingly, the interest rate swaps are included in Level 2. The funds held on behalf of others liability approximates the investments held in NAS’ long-term investment pool on behalf of TNAC. Therefore, the liability is disclosed in the same levels as the investment assets. The following table presents NAS’ fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis at December 31, 2010 (dollars in thousands): Fair value measurements at December 31 using: Fair Value Level 1 Level 2 Level 3 Financial Assets: Short-term and long-term investments: Cash equivalents $ 21,888 $ 21,888 $ - $ - Bonds and notes U.S. treasuries/government bonds 6,964 5,844 1,120 - Mortgage-backed securities 32,044 16,980 15,064 - Corporate bonds 26,122 11,146 14,976 - Non-U.S. fixed income 21,774 21,774 - -
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Report of the Treasurer of the National Academy of Sciences Fair value measurements at December 31 using: Fair Value Level 1 Level 2 Level 3 Equity securities U.S. large stock 70,619 70,619 - - U.S. small/mid cap 67,547 67,547 - - Non-U.S. stocks (developed countries) 89,016 89,016 - - Non-U.S. stocks (emerging countries) 57,054 57,054 - - Real estate stocks 11,938 11,938 - - Hedge funds Fund of fund – multi-strategies 27,104 - 27,104 - Multi-strategies/multi-vehicle 11,028 - - 11,028 Fixed income single strategy 1,185 - 1,185 - Long/short equity 15,986 - 2,500 13,486 Private equity Asia 12,725 - - 12,725 Global 4,840 - - 4,840 Domestic 2,005 - - 2,005 Total short-term and long-term investments 479,839 373,806 61,949 44,084 Deposit with trustee Bonds and notes U.S. treasuries/government bonds 47,216 47,216 - - Total deposit with trustee 47,216 47,216 Charitable gift annuity assets: Cash equivalents 56 56 - - Bonds and notes U.S. treasuries/government bonds 66 66 - - Mortgage-backed securities 376 376 - - Corporate bonds 86 86 - - Equity securities U.S. small/mid cap 1,475 1,475 - - Total charitable gift annuity assets 2,059 2,059 - - Deferred compensation assets: Cash equivalents 13 13 - - Bonds and notes U.S. treasuries/government bonds 97 97 - - Corporate bonds 426 426 - - Equity securities U.S. large stock 164 164 - - U.S. small/mid cap 1,279 1,279 - - Non-U.S. stocks (developed countries) 339 339 - - Total deferred compensation assets 2,318 2,318 - - Total financial assets $ 531,432 $ 425,399 $ 61,949 $ 44,084 Financial Liabilities: Funds held on behalf of others $ 9,918 $ 7,984 $ 795 $ 1,139 Deferred compensation liability 2,318 2,318 - - Interest rate swaps 10,534 - 10,534 - Total financial liabilities $ 22,770 $ 10,302 $ 11,329 $ 1,139
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Report of the Treasurer of the National Academy of Sciences The following table presents NAS’ fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis at December 31, 2009 (dollars in thousands): Fair value measurements at December 31 using: Fair Value Level 1 Level 2 Level 3 Financial Assets: Short-term and long-term investments: Cash equivalents $ 17,980 $ 17,980 $ - $ - Bonds and notes U.S. treasuries/government bonds 5,470 5,225 245 - Mortgage-backed securities 29,039 17,924 11,115 - Corporate bonds 26,586 9,707 16,879 - Non-U.S. fixed income 22,047 22,047 - - Equity securities U.S. large stock 66,483 66,483 - - U.S. small/mid cap 53,319 53,319 - - Non-U.S. stocks (developed countries) 88,181 88,181 - - Non-U.S. stocks (emerging countries) 48,439 48,439 - - Real estate stocks 10,161 10,161 - - Hedge funds Fund of fund – multi-strategies 34,255 - 34,255 - Multi-strategies/multi-vehicle 10,000 - - 10,000 Fixed income single strategy 1,281 - - 1,281 Private equity Asia 4,990 - - 4,990 Global 5,073 - - 5,073 Domestic 1,972 - - 1,972 Total short-term and long-term investments 425,276 339,466 62,494 23,316 Charitable gift annuity assets: Cash equivalents 125 125 - - Bonds and notes U.S treasuries/government bonds 55 55 - - Mortgage-backed securities 452 452 - - Corporate bonds 118 118 - - Equity securities U.S. small/mid cap 1,631 1,631 - - Total charitable gift annuity assets 2,381 2,381 - - Deferred compensation assets: Cash equivalents 24 24 - - Bonds and notes U.S. treasuries/government bonds 103 103 - - Corporate bonds 324 324 - - Equity securities U.S. large stock 99 99 - - U.S. small/mid cap 1,317 1,317 - - Non-U.S. stocks (developed countries) 522 522 - - Total deferred compensation assets 2,389 2,389 - - Total financial assets $ 430,046 $ 344,236 $ 62,494 $ 23,316 Financial Liabilities: Funds held on behalf of others $ 8,794 $ 7,324 $ 875 $ 595 Deferred compensation liability 2,389 2,389 - - Interest rate swaps 9,210 - 9,210 - Total financial liabilities $ 20,393 $ 9,713 $ 10,085 $ 595
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Report of the Treasurer of the National Academy of Sciences Level 3 assets comprised approximately 9% and 5% of NAS’ total investment portfolio fair value at December 31, 2010 and 2009, respectively. The following table presents the changes in Level 3 assets measured at fair value on a recurring basis for the year ended December 31, 2010 (dollars in thousands): Balance January 1, 2010 Net gain (loss) on investments Purchases Sales Transfers out of Level 3 (a) Balance December 31, 2010 Hedge funds: Multi-strategies/multi-vehicle $ 10,000 $ 1,028 $ - $ - $ - $ 11,028 Fixed income single strategy 1,281 (96) - - (1,185) (b) - Long/short equity - 486 13,000 - - 13,486 Private equity: Asia 4,990 6,407 1,428 (100) - 12,725 Global 5,073 481 90 (804) - 4,840 Domestic 1,972 251 - (218) - 2,005 $ 23,316 $ 8,557 $ 14,518 $ (1,122) $ (1,185) $ 44,084 Notes: NAS’ policy is to recognize transfers in and transfers out as of the end of the reporting period in which the event or change in circumstances occurred. Transferred from Level 3 to Level 2 due to expiration of lock up period allowing for redemption in the near term. The following table presents the changes in Level 3 assets measured at fair value on a recurring basis for the year ended December 31, 2009 (dollars in thousands): Balance January 1, 2009 Net gain (loss) on investments Purchases Sales Transfers out of Level 3 (a) Balance December 31, 2009 Hedge funds: Fund of fund - multi-strategies $ 35,243 $ (449) $ - $ (34,794) $ - $ - Multi-strategies/multi-vehicle 30,040 4,215 10,000 - (34,255) (b) 10,000 Fixed income single strategy - (68) 1,000 349 - 1,281 Private equity: Asia 4,139 155 749 (53) - 4,990 Global 5,554 (512) - 31 - 5,073 Domestic 1,991 58 - (77) - 1,972 $ 76,967 $ 3,399 $ 11,749 $ (34,544) $ (34,255) $ 23,316 Notes: NAS’ policy is to recognize transfers in and transfers out as of the end of the reporting period in which the event or change in circumstances occurred. Transferred from Level 3 to Level 2 due to expiration of lock up period allowing for redemption in the near term. The following table presents the nature and risk of assets with fair values estimated using NAV held at December 31, 2010 (dollars in thousands): Fair Value Unfunded Commitments Redemption Frequency Redemption Notice Period Fund of the hedge fund – multi-strategies (a) $ 27,104 N/A Quarterly 90 days Hedge fund – multi-strategies/multi-vehicle (b) 11,028 N/A Annually, but not currently eligible 365 days Hedge fund – fixed income single strategy (c) 1,185 N/A Quarterly 30 days Hedge fund – long/short equity strategy (d) 15,986 N/A Monthly/Quarterly/Annually 45/60/90 days Private equity – Asia (e) 12,725 2,940 N/A N/A Private equity – Global (f) 4,840 347 N/A N/A Private equity – Domestic (g) 2,005 303 N/A N/A Total $ 74,873 $ 3,590
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Report of the Treasurer of the National Academy of Sciences Notes: This class includes investments in funds of hedge funds that use multiple strategies to obtain total returns on a leveraged basis. Direct and indirect investments are made using equity long/short, event driven, relative value, and tactical trading strategies. The funds have investments in multiple investees which may trade various financial instruments such as, but not limited to, securities sold short, futures, forwards, swaps, and written options. The fair values of the investments in this class have been estimated using the NAV per share of the investments. This class includes investments in a multi-strategy, multi-vehicle hedge fund with the objective of maximizing long-term, risk-adjusted returns and capital appreciation by investing in securities, investment funds, discretionary accounts, and investment partnerships across a broad range of marketable and alternative asset classes. Asset classes include domestic and international marketable equity securities, hedged equity, real estate, natural resource, fixed income, and private equity and absolute return strategies, primarily focused in the United States. The fair values of the investments in this class have been estimated using the NAV per share of the investments. Currently, none of the investments in this class are redeemable because the fund includes restrictions that do not allow for redemption in the first 2 years after acquisition. The remaining restriction for these investments is 1 year at December 31, 2010. This class includes investments in a single strategy hedge fund focused on undervalued fixed income securities. Investments held by this fund consist of U.S. government agency mortgage-backed securities and derivatives, primarily in the form of collateralized mortgage obligations. Securities are generally held in the portfolio as long as interest rates and repayment rates are unfolding as anticipated. The majority of the investment return is expected to come from trading mortgage-backed securities in attempt to maximize interest income. The fair values of the investments in this class have been estimated using the NAV per share of the investments. The investments in this class are redeemable quarterly. This category is comprised of long-short equity hedge funds investing in securities of U.S. companies as well as securities of developed and emerging countries. The geographical allocation among U.S. equity funds, global funds and emerging market funds is approximately 42%, 42% and 16%, respectively. Each of these funds buys securities long and sells short securities with the ability to use leverage. These funds can also invest in derivative instruments such as forward, futures and options contracts. The fair values of the investments in this category have been estimated using the net asset value per share of the investments. Currently, approximately $2.5M of investments in this category is redeemable within the near term from December 31, 2010. The remaining investments are not redeemable because the funds include restrictions that do not allow for redemption in the first 12 months after acquisition. The remaining restriction for these investments is four to six months at December 31, 2010. This class includes several private equity funds that invest in equity, debt or debt-oriented instruments, primarily in privately held companies which own or contractually control operating entities located in the Peoples’ Republic of China and India. Investments held in India primarily include equity securities of “early to early growth stage” companies in multiple sectors, except real estate. The fair values of these investments have been estimated using the NAV of NAS’ ownership interest in partners’ capital. These investments can never be redeemed with the funds. Instead, the nature of the investments in this class is that distributions are received through liquidation of the underlying assets of the funds. It is estimated that the underlying assets of the funds will be liquidated over 1 to 8 years. This class includes several global private equity funds with diverse portfolios consisting primarily of venture capital funds, leveraged buyout funds, mid-stage growth capital funds, and international private equity funds. These investments are focused on several industries including, but not limited to, insurance, services, and consumer-related industries. The fair values of these investments have been estimated using the NAV of NAS’ ownership interest in partners’ capital. These investments can never be redeemed with the funds. Instead, the nature of the investments in this class is that distributions are received through liquidation of the underlying assets of the funds. It is estimated that the underlying assets of the funds will be liquidated over 1 to 5 years. This class includes several domestic private equity funds which make investments in domestic equity securities, warrants or other securities that are generally not actively traded at the time of investment. These investments are focused on several industries including, but not limited to, insurance, financial services, consumer-related, and communications. The fair values of these investments have been estimated using the NAV of NAS’ ownership interest in partners’ capital. These investments can never be redeemed with the funds. Instead, the nature of the investments in this class is that distributions are received through liquidation of the underlying assets of the funds. It is estimated that the underlying assets of the funds will be liquidated over 1 to 2 years.
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Report of the Treasurer of the National Academy of Sciences (5) PROPERTY AND EQUIPMENT Property and equipment as of December 31, 2010 and 2009, is comprised of the following (dollars in thousands): 2010 2009 Land $ 29,689 $ 29,689 Furniture and equipment 35,030 36,195 Buildings and improvements 109,518 109,396 Construction in progress 14,207 5,568 Software development in process 5,062 1,255 Leasehold improvements 4,635 7,437 198,141 189,540 Less accumulated depreciation and amortization (63,188) (62,064) Total property and equipment, net $ 134,953 $ 127,476 (6) CONTRIBUTIONS RECEIVABLE Contributions not yet collected are included in contributions and other receivables (current) and contributions receivable (long-term) in the statements of financial position, and mature as follows (dollars in thousands): Years ending December 31: 2011 $ 11,156 2012 7,110 2013 4,164 2014 3,764 2015 3,901 Thereafter 5,481 35,576 Less discount at rates from 3% to 6.75% to estimated net present value (2,185) Less allowance for uncollectible contributions (701) 32,690 Less current portion (10,455) Total contributions receivable, long-term $ 22,235 At December 31, 2009, the discount on contributions receivable was approximately $3.0 million at rates ranging from 3% to 6% and the allowance for uncollectible contributions was approximately $453,000. (7) DEFERRED REVENUE Deferred revenue consisted of the following as of December 31, 2010 and 2009 (dollars in thousands): 2010 2009 Advances from private grants and contract sponsors $15,828 $22,257 Advances from U.S. government sponsors 7,320 4,692 Publication subscriptions and other 4,859 5,131 Total deferred revenue $28,007 $32,080 (8) LINE OF CREDIT NAS is party to a $22 million unsecured line of credit from Bank of America, which bears interest at LIBOR plus 0.65% and expires on August 30, 2011. Effective November 1, 2010, NAS is also party to a $15 million unsecured line of credit from Wells Fargo, which bears interest at LIBOR plus 0.65% and expires on October 31, 2011. Interest expense related to the lines of credit for the years ended December 31, 2010 and 2009, was approximately $84,000 and $68,500, respectively. (9) TEMPORARILY RESTRICTED NET ASSETS Temporarily restricted net assets were available for the following purposes as of December 31, 2010 and 2009 (dollars in thousands): 2010 2009 Sponsored research and advisory programs $156,557 $147,050 General endowment 79,400 69,107 Prizes and awards 26,385 22,784 Woods Hole facility 3,360 2,793 Total temporarily restricted net assets $265,702 $241,734 Temporarily restricted net assets were released from restriction for the following purposes during the years ended December 31, 2010 and 2009 (dollars in thousands): 2010 2009 Sponsored research and advisory programs $ 32,040 $ 30,788 General endowment 4,927 5,732 Prizes and awards 799 728 Woods Hole facility 372 390 Total temporarily restricted net assets released from restriction $ 38,138 $ 37,638
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Report of the Treasurer of the National Academy of Sciences (10) ENDOWMENT (a) Permanently Restricted Net Assets The income generated by permanently restricted net assets is available to support donor-specified programs. As of December 31, 2010 and 2009, NAS held the following permanently restricted net assets, classified by the purpose for which the income is to be used (dollars in thousands): 2010 2009 Sponsored research and advisory programs $113,253 $110,122 Prizes and awards 5,116 5,240 Total permanently restricted net assets $118,369 $115,362 (b) Endowment Assets The NAS endowment consists of approximately 110 individual funds established to support general operations, sponsored research and advisory programs, prizes and awards, and the operations of the Woods Hole facility. The endowment is comprised solely of donor-restricted endowment funds. The investments of the endowment are included in the NAS long-term investment pool, as described in note 3. Interpretation of Relevant Law NAS has interpreted the District of Columbia “Uniform Prudent Management of Institutional Funds Act of 2007” (the Act) as requiring NAS, absent explicit donor stipulations to the contrary, to act in good faith and with the care that an ordinarily prudent person in a like position would exercise under similar circumstances in making determinations to appropriate or accumulate endowment funds, taking into account both its obligation to preserve the value of the endowment and its obligation to use the endowment to achieve the purposes for which it was donated. NAS classifies as permanently restricted net assets (a) the original value of gifts donated to the permanent endowment, (b) the original value of subsequent gifts to the permanent endowment, and (c) accumulations to the permanent endowment required by the applicable donor gift instrument. The remaining portion of donor-restricted endowment funds that are not classified as permanently restricted are classified as temporarily restricted net assets until those amounts are appropriated for expenditure by NAS. In making a determination to appropriate or accumulate, NAS adheres to the standard of prudence prescribed by the Act and considers the following factors: The duration and preservation of the endowment fund; The purposes of the institution and the endowment fund; General economic conditions; The possible effect of inflation or deflation; The expected total return from income and the appreciation of investments; Other resources of the institution; and The investment policy of the institution. Return Objectives and Strategies NAS has adopted an investment and spending policy for endowment assets that is designed to provide a predictable stream of funding to programs supported by the endowment while seeking to protect the real purchasing power of the assets from inflation. Accordingly, NAS has adopted guidelines which feature a material commitment to equity and equity-like investments. The asset allocation guidelines are as follows: Asset Category Guideline % U.S. large stocks 25% U.S. small-mid stocks 12% Non-U.S. stocks (developed) 20% Non-U.S. stocks (emerging) 8% Real estate stocks 5% Total equity 70% U.S. fixed/cash 12% Non-U.S. fixed 3% Total fixed 15% Hedge funds and alternative investments 15% Total 100% NAS has adopted a spending policy that limits the annual spending to 5% of the three-year average fair value of the participating funds in the endowment portfolio. This is consistent with NAS’ objective to maintain the purchasing power of the endowment assets held in perpetuity as well as to provide additional real growth through new gifts and investment return.
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Report of the Treasurer of the National Academy of Sciences Changes in endowment assets for the fiscal year ended December 31, 2010 are as follows (dollars in thousands): Unrestricted Temporarily Restricted Permanently Restricted Total Endowment assets, January 1, 2010 $ (214) $ 152,382 $ 111,055 $ 263,223 Investment return: Interest and dividend income - 5,021 - 5,021 Net gain on investments 214 34,530 - 34,744 Total investment return 214 39,551 - 39,765 Contributions - - 3,147 3,147 Amounts appropriated for expenditure - (11,074) - (11,074) Other changes: 2009 appropriation expended in 2010 - (2,604) - (2,604) Unspent purpose restricted appropriations - 2,443 - 2,443 Accrued expenses withdrawn in 2011 - 170 - 170 Endowment assets, December 31, 2010 $ - $ 180,868 $ 114,202 $ 295,070 Changes in endowment assets for the fiscal year ended December 31, 2009 are as follows (dollars in thousands): Unrestricted Temporarily Restricted Permanently Restricted Total Endowment assets, January 1, 2009 $ (2,412) $ 112,988 $ 108,524 $ 219,100 Investment return: Interest and dividend income - 4,822 - 4,822 Net gain on investments 2,198 46,101 - 48,299 Total investment return 2,198 50,923 - 53,121 Contributions - - 2,531 2,531 Amounts appropriated for expenditure - (11,089) - (11,089) Other changes: 2008 appropriation expended in 2009 - (3,044) - (3,044) Unspent purpose restricted appropriations - 2,022 - 2,022 Accrued expenses withdrawn in 2010 - 582 - 582 Endowment assets, December 31, 2009 $ (214) $ 152,382 $ 111,055 $ 263,223 Funds with Deficiencies From time to time, the fair value of assets associated with individual donor-restricted endowment funds may fall below the original value of the gift donated to the permanent endowment. Deficiencies of this nature are reported as unrestricted net assets. At December 31, 2010, there were no endowment funds with a fair value below the original value of the gift. At December 31, 2009, NAS had deficiencies of $214,000 reported as unrestricted net assets. These deficiencies were primarily a result of unfavorable market fluctuations that occurred shortly after the investment of new permanently restricted contributions. Subsequent gains that restored the fair value of the assets of the endowment fund to the required level were classified as an increase in unrestricted net assets.
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Report of the Treasurer of the National Academy of Sciences (11) PROGRAM EXPENSES Program expenses for the years ended December 31, 2010 and 2009 are summarized as follows (dollars in thousands): 2010 2009 Transportation Research Board $112,445 $ 97,045 Policy and Global Affairs 55,117 51,111 Institute of Medicine 32,116 27,519 Earth and Life Sciences 21,371 22,123 Engineering and Physical Sciences 18,250 21,043 Behavioral and Social Sciences and Education 12,042 10,268 Proceedings of the National Academy of Sciences 11,762 13,425 National Academy Press 4,412 4,351 National Academy of Engineering 3,158 4,079 Koshland Science Museum 1,850 1,616 NAS 7,834 8,129 Total program expenses $280,357 $260,709 (12) RECOVERY OF INDIRECT COSTS NAS receives indirect cost recovery on its federal contracts and grants. An overhead assessment is applied to direct salaries, accrued leave, fringe benefits, and services provided by outside contractors (e.g., temporary personnel agencies, consultants) on NAS property. A general and administrative assessment (G&A) is applied to direct costs and overhead less subcontract costs and stipends. Therefore, both the overhead and G&A rates are applied to projects incurring direct salaries and other direct costs such as travel. If a program does not require direct salaries, such as a travel grant program, a subcontract/flow-through administration rate is applied. Certain off-site work (not performed on NAS property) is assessed reduced overhead rates. NAS bills for indirect cost recovery throughout the year based on negotiated rates. At the end of each year, NAS compares actual expenses incurred in each of its cost pools to the amounts recovered based on its billing rates. The difference is recorded as its indirect cost carryforward. If NAS over recovers on its indirect costs during the year, a liability is recorded. If NAS under recovers, a receivable is recorded. NAS has a cumulative net overrecovery of approximately $4.8 million and $2.4 million as of December 31, 2010 and 2009, respectively. The overrecovery is included in the deferred revenue balance in the statements of financial position. (13) BUILDING PROJECT AND FINANCING (a) Building Project Revenue Bonds In January 1999, the District of Columbia issued Series 1999A, Series 1999B, and Series 1999C tax-exempt revenue bonds in the total amount of $130,960,000 on behalf of NAS. Proceeds from the sale of the revenue bonds financed the cost of the acquisition of 44,250 square feet of land and related construction of an office building, as well as paid certain costs of issuing the bonds. This building consolidates most of NAS’ program activities into one location. The facility was occupied in July 2002. In June 2008, the District of Columbia issued Series 2008A tax-exempt revenue bonds in the amount of $66,325,000 on behalf of NAS. The proceeds were used to refund the Series 1999B and Series 1999C revenue bonds, as well as pay certain costs of issuing the bonds. In April 2009, the District of Columbia issued Series 2009A tax-exempt revenue bonds in the amount of $57,500,000 on behalf of NAS. The proceeds were used to refund the Series 1999A revenue bonds, as well as pay certain costs of issuing the bonds. In May 2010, the District of Columbia issued Series 2010A tax-exempt revenue bonds in the amount of $59,550,000 on behalf of NAS. These bonds were sold to finance the cost to restore the NAS headquarters building on Constitution Avenue in Washington, D.C. and pay for certain costs of issuance. The restoration is expected to be completed in April 2012. The bond proceeds are held by a Trustee and invested in U.S. government obligations or funds of U.S. government obligations. The Trustee reimburses NAS and third-party vendors for expenditures related to the restoration project.
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Report of the Treasurer of the National Academy of Sciences NAS is obligated under the revenue bonds as follows (dollars in thousands): 2010 2009 Series 2008A revenue bonds, term, at flexible rates (0.3% in 2010 and 0.6% in 2009) maturing at various dates from January 1, 2029 through 2039 $ 66,325 $ 66,325 Series 2009A revenue bonds, term, at flexible rates (0.3% in 2010 and 0.4% in 2009) maturing at various dates from January 1, 2010 through 2028 56,220 57,500 Series 2010A revenue bonds, serial, with interest rates ranging from 3.0% to 5.0%, maturing at various dates from April 1, 2013 through 2030 29,385 - Series 2010A revenue bonds, term, Interest rate 5%, maturing April 1, 2035 13,205 - Interest rate 5%, maturing April 1, 2040 16,960 - Total bonds, at face value 182,095 123,825 Plus unamortized premium 1,244 - Total bonds payable 183,339 123,825 Less current portion (included in other current liabilities) (2,137) (1,280) Bonds payable, long-term $ 181,202 $ 122,545 The serial and term bonds represent unsecured general obligations of NAS. Interest on the 2008A and 2009A bonds is payable monthly. Interest on the 2010A bonds is payable semiannually every April 1 and October 1. The term bonds maturing on April 1, 2035, and April 1, 2040, are subject to mandatory redemption by operation of sinking fund installments. Installment payments for the term bond maturing April 1, 2035, begin on April 1, 2031, and range from $2.4 to $2.9 million per year through the maturity date. Installment payments for the term bond maturing April 1, 2040, begin on April 1, 2036, and range from $3.1 to $3.8 million per year through the maturity date. Scheduled maturities and sinking fund requirements are as follows (dollars in thousands): Years ending December 31: 2011 $ 2,000 2012 2,100 2013 3,325 2014 3,475 2015 3,645 Thereafter 167,550 $ 182,095 The carrying value of bonds payable in the financial statements was approximately $3.7 million greater than fair value as of December 31, 2010 and was approximately equal to fair value on December 31, 2009. Interest expense on the bonds payable for 2010 and 2009 totaled $2.0 million and $1.5 million, respectively. Of this amount, $1.4 million was capitalized as part of the building restoration project for 2010. No interest expense was capitalized for 2009. (b) Interest Rate Swaps In October 1999, NAS entered into a swap agreement, with an effective date of February 1, 2000, relating to the $66 million face amount of its Series 1999A revenue bonds. The agreement provides for NAS to receive 4.97% in interest on a notional amount of $65 million and to pay interest at a floating rate option based on the weekly interest rate resets of tax-exempt variable-rate issues per the SIFMA Municipal Swap Index. NAS amended the agreement for the 2005 – 2020 period by agreeing to give up the benefit of any 30-day period during which the SIFMA index remains below 2.25% for the entire 30 days. Each time this occurs, the rate on the swap portfolio reverts to the fixed rate noted above for that month only. NAS entered into this fixed-to-variable swap agreement to manage its exposure to interest rate changes. The fixed-rate debt obligations exposed NAS to variability in the cost recovery stream due to changes in interest rates. NAS recovers the costs of borrowing through a capital investment incentive rate that is set by the U.S. government and is tied to a variable index. If interest rates increase, the capital investment incentive recovery increases. Conversely, if interest rates decrease, the capital investment incentive recovery decreases. Therefore, NAS entered into a derivative instrument that ties the fixed-rate debt to a variable index to manage fluctuations in cash flows resulting from interest rate risk. By using derivative financial instruments to hedge exposures to changes in interest rates, NAS exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes NAS, which creates credit risk for NAS. When the fair value of a derivative contract is negative, NAS owes the counterparty, and therefore, it does not possess credit risk. NAS minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties.
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Report of the Treasurer of the National Academy of Sciences In May 2009, NAS entered into an additional swap agreement as a result of a counterparty exercising a swaption related to the Series 1999A Revenue Bonds. The variable-to-fixed swap requires NAS to pay 5.00% on a notional amount of $55 million and to receive a floating rate equal to 67% of 1-month LIBOR plus 0.41%. The counterparty paid NAS $1.8 million upon execution of the swaption in 2009. NAS entered into this variable-to-fixed swap agreement in order to preserve the synthetic variable rate achieved through the 1999 swap agreement once the fixed-rate Series 1999A bonds were refunded with the variable-rate Series 2009A bonds. As required by the Derivatives and Hedging topic of the FASB ASC, the fair value of the fixed-to-variable swap and the variable-to-fixed swap are recorded in the NAS financial statements. Accordingly, with regard to the fixed-to-variable interest rate swap, NAS recorded a gain on the change in the fair value of its swap agreement of $17,000 for the year ended December 31, 2010 and a loss of $902,000 for the year ended December 31, 2009, which is included in other income in the accompanying statements of activities. The fair value of the interest rate swap is recorded as an asset of $17,000 as of December 31, 2010 and is included in other assets in the statements of financial position. The fair value of this interest rate swap was recorded as a liability of $35,000 as of December 31, 2009, and is included in other long-term liabilities in the statements of financial position. Pertaining to the swaption and resultant variable-to-fixed interest rate swap, NAS recorded a loss on the change in the fair value of approximately $1.3 million for the year ended December 31, 2010 and a gain of $3.6 million for the year ended December 31, 2009. The gain and loss are included in other income in the statements of activities. The fair value of the swap is recorded as a liability of $10.5 million and $9.2 million at December 31, 2010 and 2009, respectively, and is included in other current liabilities and other long-term liabilities. (14) NOTE PAYABLE During 2006, NAS entered into a loan agreement with Bank of America for an amount up to $5 million. The principal balance of this note is payable in equal monthly installments until January 1, 2012. On December 31, 2010 and 2009, the principal balance was approximately $0.8 million and $1.5 million, respectively. The note bears interest at 30-day LIBOR plus 40 basis points. The interest rate at December 31, 2010 and 2009 was 0.66% and 0.63%, respectively. (15) EMPLOYEE BENEFITS (a) Retirement Plans NAS has a noncontributory defined contribution retirement plan covering substantially all of its employees (based on certain benefit eligibility requirements). The plan is intended to qualify under Section 401(a) of the Internal Revenue Code and uses Teachers Insurance and Annuity Association/College Retirement Equities Fund (TIAA/CREF) group retirement annuity contracts as the investment vehicle. Participants in this plan vest immediately. NAS has received a favorable determination letter from the IRS on the qualification of this plan under Section 401(a) of the Internal Revenue Code. In addition, NAS has a voluntary employee contribution retirement plan that is funded solely by employee contributions made on a pretax salary-reduction basis under Section 403(b) of the Internal Revenue Code. The investment vehicles under this voluntary plan are retirement annuity contracts issued by TIAA/CREF and mutual funds offered by the Vanguard Group, Inc. Pension expense for the years ended December 31, 2010 and 2009, amounted to approximately $12.0 million and $11.2 million, respectively. The NAS policy is to fund pension benefits as they are earned. The NAS normal retirement age is 60, but there is no mandatory age for retirement. (b) Deferred Compensation NAS holds long-term investments as part of a frozen deferred compensation arrangement for certain employees. The fair value of these investments was approximately $2.3 million and $2.4 million as of December 31, 2010 and 2009, respectively, which is reported within other assets in the statements of financial position. The related obligation is included in accrued employee benefits in the statements of financial position. (c) Postretirement and Postemployment Benefits NAS provides certain health and life insurance benefits for employees retired due to length of service. All benefit-eligible employees may become eligible for service retiree benefits if they reach age 60 while working for NAS and complete 5 years of service in a benefit-eligible status for medical and life insurance benefits. In addition, certain health and life insurance
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Report of the Treasurer of the National Academy of Sciences benefits are provided for employees retired due to disability. A benefit-eligible employee may become eligible for disabled retiree benefits if deemed totally disabled under NAS’ long-term disability insurance or if they are eligible for disability benefits from the Social Security Administration. Life insurance benefits are provided based on coverage at date of disability and health insurance may be continued if the disabled retiree had participated in an NAS health insurance plan for 5 years at the date of disability. Insurance companies whose premiums are determined on an experience-rated basis provide life and health insurance benefits for retirees. Medicare supplement insurance is not experience rated. The retiree welfare benefit plan is contributory for health insurance purposes for employees who retired on or after January 1, 1990. Participant contributions for health insurance are based on a percentage of the monthly premium paid by NAS (from 25% to 100%). The participant contribution is also based on their date of retirement, length of service and choice of health insurance carrier. NAS has elected to recognize the initial postretirement benefit obligation over a period of 20 years. The accrued postretirement benefit obligation is reported in accrued employee benefits in the statements of financial position. Postretirement changes other than net periodic benefit cost are as follows (dollars in thousands): 2010 2009 Net actuarial loss (gain) $ 1,041 $ (1,464) Recognized net actuarial loss (190) (469) Recognized prior service cost (210) (210) Recognized net initial obligation (26) (26) Total $ 615 $ (2,169) Items not yet recognized as a component of net periodic benefit cost at December 31, 2010 and 2009 are as follows (dollars in thousands): 2010 2009 Net actuarial loss $ 4,365 $ 3,513 Prior service cost 932 1,142 Unrecognized net initial obligation 90 117 Total $ 5,387 $ 4,772 The estimated amounts, measured at year-end, that are expected to be recognized in the net periodic benefit cost over the next fiscal year for the postretirement benefit plan are as follows (dollars in thousands): 2010 2009 Prior service cost $ 210 $ 210 Recognized actuarial loss 302 190 Recognized net initial obligation 26 26 Total $ 538 $ 426 The following table presents the changes in benefit obligations, changes in plan assets, funded status, and the components of net periodic benefit cost for the year ended December 31, 2010 and 2009 (dollars in thousands): 2010 2009 Change in benefit obligations: Benefit obligation, January 1 $ 19,914 $ 18,592 Service cost 625 613 Interest cost 1,168 1,088 Plan participants contributions 105 101 Actuarial loss 1,307 170 Benefits paid (635) (650) Benefits obligation, December 31 22,484 19,914 Change in plan assets, combined: Fair value of plan assets, January 1 17,701 12,200 Actual return on plan assets 1,593 2,550 Employer contributions 891 2,951 Fair value of plan assets, December 31 20,185 17,701 Funded status $ (2,299) $ (2,213) Components of net periodic benefit cost: Service cost $ 625 $ 613 Interest cost 1,168 1,088 Expected return on plan assets (1,328) (915) Recognized prior service cost 210 210 Recognized actuarial loss 190 469 Recognized net initial obligation 26 26 Net periodic benefit cost $ 891 $ 1,491 The assumptions used to determine net periodic benefit cost for years ended December 31, 2010 and 2009 are as follows: 2010 2009 Discount rate 6.00% 6.00% Expected long-term return on plan assets 7.50% 7.50%
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Report of the Treasurer of the National Academy of Sciences The assumptions used to calculate the accumulated postretirement benefit obligation for the years ended December 31, 2010 and 2009 are as follows: 2010 2009 Discount rate 5.25% 6.00% NAS postretirement benefit plan asset allocations at December 31, 2010 and 2009, by asset class are as follows: 2010 2009 Cash 5% 3% Bonds and notes 18% 22% Equity securities 77% 75% 100% 100% The investment objective of the Plan is to produce a rate of return over the long term that will provide for fund growth, protect against the effect of inflation, and provide for some stability in different market environments. The fund is diversified between fixed income and equity investments. With this diversification and investment in broader market funds, there is reasonable assurance that no single security or class of securities will have a disproportionate impact on the Plan assets. The Plan assets are invested with a long-term growth strategy, with a 70% equity guideline. The overall long-term rate of return was developed by estimating the long-term real rate of return for the Plan’s asset mix, while taking into account the effects of inflation. This estimate was developed by evaluating the history and similar asset allocation of the NAS Endowment. The following table presents the fair value hierarchy for the postretirement benefit plan assets at December 31, 2010 (dollars in thousands): Fair value measurements at December 31 using: Fair Value Level 1 Level 2 Level 3 Financial Assets: Retiree Welfare Benefit Plan investments: Cash equivalents $ 1,034 $ 1,034 $ - $ - Bonds and notes U.S. treasuries/gov. bonds 2,395 2,395 - - Mortgage-backed securities 1,294 - 1,294 - Corporate bonds 3,879 3,879 - - Equity securities U.S. small/mid cap 9,823 9,823 - - Non-U.S. stocks (developed countries) 1,760 1,760 - - Total investments $20,185 $18,891 $ 1,294 $ - The following table presents the fair value hierarchy for the postretirement benefit plan assets at December 31, 2009 (dollars in thousands) Fair value measurements at December 31 using: Fair Value Level 1 Level 2 Level 3 Financial Assets: Retiree Welfare Benefit Plan investments: Cash equivalents $ 519 $ 519 $ - $ - Bonds and notes U.S. treasuries/gov. bonds 2,505 2,505 - - Mortgage-backed securities 911 - 911 - Corporate bonds 4,109 3,560 549 - Equity securities U.S. small/mid cap 7,408 7,408 - - Non-U.S. stocks (developed countries) 2,249 2,249 - - Total investments $ 17,701 $ 16,241 $ 1,460 $ - The methods and assumptions used to estimate the fair value of each class of financial instrument are further discussed in footnote 4, Fair Value Measurements.
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Report of the Treasurer of the National Academy of Sciences NAS expects to contribute to the Plan the actuarially determined net periodic cost for 2011, which is approximately $849,000. The following benefit payments, which reflect future services, are expected to be paid in future years as noted, as of December 31, 2010 (dollars in thousands): Years ending December 31: 2011 $ 927 2012 1,104 2013 1,233 2014 1,323 2015 1,432 2016-2020 7,670 $ 13,689 The measurement date of the plan assets and benefit obligations for 2010 and 2009 is December 31, 2010 and 2009, respectively. The trend rate for growth in healthcare costs used in calculating the accumulated postretirement benefit obligation was 8.5% for under age 65 and 6.5% for over age 65 declining gradually to 5% in the year 2017 and 2013 for under age 65 and over age 65, respectively for year ended December 31, 2010. The trend rate for growth in healthcare costs was 9.0% for under age 65 and 7.0% for over age 65 for the year ended December 31, 2009, declining gradually to 5% in the year 2019. The healthcare cost trend rate assumption has a significant impact on the postretirement benefit costs and obligations. The effect of a 1% change in the assumed healthcare cost trend rate at December 31, 2010, would have resulted in an estimated $2.4 million increase or $2.0 million decrease in the postretirement benefit obligation and an estimated $226,000 increase or $186,000 decrease in the 2010 benefit expense. The effect of a 1% change in the assumed healthcare cost trend rate at December 31, 2009, would have resulted in an estimated $2.0 million increase or $1.7 million decrease in the postretirement benefit obligation and an estimated $215,000 increase or $177,000 decrease in the 2009 benefit expense. (16) CONDITIONAL ASSET RETIREMENT OBLIGATION The Asset Retirement Obligation subtopic of FASB ASC requires a liability to be recorded if the fair value of the obligation to retire an asset can be reasonably estimated. Asset retirement obligations include those for which an entity has a legal obligation to perform an asset retirement activity. However, the timing and/or method of settling the obligation are conditional on a future event that may or may not be within the control of the entity. NAS recorded an asset retirement obligation for which fair value of the liability could be reasonably estimated relating to the regulatory remediation of asbestos and other hazardous materials in one of its office buildings. During 2010, NAS remediated a significant portion of the asbestos and hazardous materials with the remaining remediation expected to occur in early 2011. NAS recognized a gain on the settlement of the asset retirement obligation of $785,000 for the year ended December 31, 2010, which is included in other income in the statement of activities. For the years ended December 31, 2010 and 2009, NAS has a liability of $60,000 and $1,840,000 included in other long-term liabilities in the statements of financial position. Accretion expense of $0 and $84,000 were included in management and general expense for the years ended December 31, 2010 and 2009, respectively. (17) RELATED PARTY TRANSACTIONS The NAS Council has authorized two agreements providing noninterest-bearing, collateralized advances to two employees in connection with the purchase of each employee’s residence. The agreements between the parties were executed in May 2005 and May 2007. They each provide that the repayment obligation will be adjusted to allocate to each party its proportional share of the appreciation or depreciation in the value of the residence, which is based on the relative financing percentage provided by each party. The agreements will terminate upon pay-back of the advance, sale of the property, or the end of each individual’s employment with NAS, which will not exceed 12 years. The estimated present value of the receivables is $3.0 million and $3.3 million at December 31, 2010 and 2009, respectively, and is included in other assets in the statements of financial position. (18) COMMITMENTS AND CONTINGENCIES (a) Leases NAS is committed to several noncancelable operating leases for office space. Future minimum rental payments due under noncancelable operating leases are as follows (dollars in thousands):
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Report of the Treasurer of the National Academy of Sciences Years ending December 31: 2011 $ 3,120 2012 2,234 2013 1,730 2014 1,776 2015 1,822 Thereafter 1,522 $ 12,204 Rental expense amounted to approximately $3.0 million and $2.6 million for years ended December 31, 2010 and 2009, respectively. (b) Contingencies NAS receives a portion of its revenues directly or indirectly from federal government grants and contracts, all of which are subject to audit by the Defense Contract Audit Agency, which has completed its examinations through December 31, 2005. A contingency exists relating to unexamined periods and final settlements of examined periods to refund any amounts received in excess of allowable costs. Management is of the opinion that no material liability will result from such audits. (c) Litigation NAS is involved in two litigation matters. While the ultimate outcome of the litigation is uncertain, NAS management believes that it has a strong legal position, intends to vigorously defend against any liability, and has concluded that the probable outcome will not have a material impact on NAS. (19) RISKS AND UNCERTAINTIES NAS invests in various investment securities. Investment securities are exposed to various risks such as interest rate, market and credit risks. Due to the level of risk associated with investment securities, it is at least reasonably possible that changes in the values of investment securities will occur in the near term and that such changes could materially affect the amounts reported. (20) SUBSEQUENT EVENT NAS has evaluated subsequent events from the balance sheet date through May 25, 2011, the date at which the financial statements were available to be issued, and determined that there are no other items to disclose.
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Report of the Treasurer of the National Academy of Sciences OFFICERS Ralph J. Cicerone, President Barbara A. Schaal, Vice President John I. Brauman, Home Secretary Michael T. Clegg, Foreign Secretary Jeremiah P. Ostriker, Treasurer FINANCE COMMITTEE Jeremiah P. Ostriker, Chair Elwyn R. Berlekamp Ralph J. Cicerone David Donoho Robert Engle Ronald L. Graham Maxine Singer IOM Representative: Larry Shapiro BUDGET AND INTERNAL AFFAIRS COMMITTEE Jeremiah P. Ostriker, Chair Rita R. Colwell Robert Dynes David Ginsburg Barbara A. Schaal Susan Taylor AUDITING COMMITTEE Jerry P. Gollub, Chair George Gloeckler Susan Gottesman Ronald L. Graham Robert H. Wurtz FINANCIAL MANAGEMENT STAFF Didi Salmon, Chief Financial Officer Craig Meyer, Controller