Benefit plans: The Company sponsors a number of defined benefit pension plans that cover eligible associates. The Company also sponsors several  funded and unfunded postretirement plans that provide health care and life insurance benefits for eligible retirees and their dependents.  These plans are accounted for in accordance with accounting rules for defined benefit pension plans and postretirement plans. The measurement of liabilities related to these plans is based on management’s assumptions related to future events, including discount  rates, rates of return on pension plan assets, rates of compensation increases and health care cost trend rates. Management regularly  evaluates these assumptions and adjusts them as required and appropriate. Other plan assumptions are also reviewed on a regular  basis to reflect recent experience and the Company’s future expectations. Actual experience that differs from these assumptions may  affect future liquidity, expense and the overall financial position of the Company. While the Company believes that current assumptions  are appropriate, significant differences in actual experience or significant changes in these assumptions may materially affect the  Company’s pension and other postretirement employee benefit obligations and its future expense and cash flow. A discount rate is used to calculate the present value of expected future pension and postretirement cash flows as of the measurement  date. The Company establishes the discount rate by constructing a portfolio of high-quality corporate bonds and matching the coupon  payments and bond maturities to projected benefit payments under the Company’s pension and postretirement welfare plans. The  bonds included in the portfolio are generally non-callable. A lower discount rate will result in a higher benefit obligation; conversely, a  higher discount rate will result in a lower benefit obligation. The discount rate is also used to calculate the annual interest cost, which is  a component of net periodic benefit cost. For expense purposes in 2011, the Company applied a discount rate of 5.75% for the defined benefit pension plans and 5.50% for the  postretirement welfare plans. For expense purposes for 2012, the Company will apply a discount rate of 5.00% for the defined benefit  pension plans and 4.85% for the postretirement welfare plans. A .25 percentage point reduction in the discount rate would increase net  periodic pension benefit cost by approximately $5.0 million for the defined benefit pension plans and $0.5 million for the postretirement  welfare plans for 2012. The expected rate of return on plan assets is determined by analyzing the historical long-term performance of the Company’s pension  plan assets, as well as the mix of plan assets between equities, fixed income securities and other investments, the expected long-term  rate of return expected for those asset classes and long-term inflation rates. Short-term asset performance can differ significantly from  the expected rate of return, especially in volatile markets. A lower-than-expected rate of return on pension plan assets will increase  pension expense and future contributions. For expense purposes in 2011, the Company applied an expected rate of return of 8.50%  for the Company’s pension plan assets. For expense purposes for 2012, the Company will apply an expected rate of return on plan  assets of 8.25%. A .25 percentage point reduction in the expected rate of return would increase net periodic pension benefit cost by  approximately $6.0 million for 2012. At the end of 2010, the Company established a VEBA trust for certain bargained associates’ retiree  medical benefits. For expense purposes in 2011, the Company applied an expected rate of return of 5.0% to the VEBA trust assets.  For expense purposes for 2012, the Company will continue to apply an expected rate of return of 5.0% to the VEBA trust assets. A .25  percentage point reduction in the expected rate of return would increase net periodic postretirement benefit cost by approximately  $0.5 million for 2012.  For measurement purposes for postretirement benefits, the Company assumed a weighted-average annual rate of increase in per  capita cost (health care cost trend rate) for medical benefits of 7.9% for 2012, declining steadily for the next 66 years to 5.0%; and  9.0% for prescription drug benefits for 2012, declining steadily for the next 66 years to 5.0%. The assumed health care cost trend  rate may have a significant effect on the amounts reported. A one percentage point increase in the assumed health care cost  trend rate would have increased the 2011 total service and interest cost components by $0.8 million and would have increased the  postretirement obligation by $15.3 million. A one percentage point decrease would provide corresponding reductions of $0.8 million  and $14.2 million, respectively. The U.S. Medicare Prescription Drug, Improvement and Modernization Act of 2003 (Medicare Act) provides for prescription drug  benefits under Medicare Part D (Medicare Subsidy) and contains a tax-free subsidy to plan sponsors who provide “actuarially  equivalent” prescription plans. The Company’s actuary determined that the prescription drug benefit provided by the Company’s  postretirement plan is considered to be actuarially equivalent to the benefit provided under the Medicare Act. The effects of the  Medicare Act include reductions to the accumulated postretirement benefit obligation and net periodic postretirement benefit cost of  $63.4 million and $5.6 million, respectively. The 2011 expected Medicare Subsidy was $3.2 million, of which $0.9 million was received  prior to December 31, 2011. THE TIMKEN COMPANY 39 MANAgEMENT’s dIsCussION ANd ANAlYsIs OF FINANCIAl CONdITION ANd rEsulTs OF OPErATIONs 