The basic goal underlying the pension plan investment policy is to ensure that the assets of the plan, along with expected plan sponsor contributions, will be invested in a prudent manner to meet the obligations of the plan as those obligations come due. Investment practices must comply with the requirements of the Employee Retirement Income Security Act of 1974 (ERISA) and any other applicable laws and regulations. An increase in the minimum pension liability resulted in a charge to shareholders’ equity of $21 in 2004 and $39 in 2003. Numerous asset classes with differing expected rates of return, return volatility, and correlations are utilized to reduce risk by providing diversification. Debt securities comprise a significant portion of the portfolio due to their plan-liability- matching characteristics and to address the plan’s cash flow requirements. Additionally, diversification of investments within each asset class is utilized to further reduce the impact of losses in single investments. The use of derivative instruments is permitted where appropriate and necessary for achieving overall investment policy objectives. The discount rate is based on settling the pension obligation with high grade, high yield corporate bonds, and the rate of compensation increase is based upon actual experience. Weighted average assumptions used to determine the net periodic benefit cost are as follows: Alcoa expects to contribute $57 to its pension plans in 2005. Alcoa also sponsors a number of defined contribution pension plans. Expenses were $118 in 2004, $107 in 2003, and $101 in 2002. Benefit payments expected to be paid to plan participants and expected subsidy receipts are as follows: The expected return on plan assets is based on historical performance as well as expected future rates of return on plan assets considering the current investment portfolio mix and the long-term investment strategy. Assumed health care cost trend rates are as follows: The health care cost trend rate in the calculation of the 2003 benefit obligation was 9.0% from 2003 to 2004 and 8.0% from 2004 to 2005. Actual company health care trend experience in2003and2004was7 .5%and5.0%,respectively.The8% trend rate will be maintained for 2005. Other Financial Instruments. The carrying values and fair values of Alcoa’s financial instruments at December 31 follow. Alcoa’s pension and postretirement plans’ investment policy, weighted average asset allocations at December 31, 2004 and 2003, and target allocations for 2005, by asset category, areasfollows: The methods used to estimate the fair values of certain financial instruments follow. Cash and Cash Equivalents, Short-Term Investments, Short-Term Debt, and Commercial Paper. The carrying amounts approximate fair value because of the short maturity of the instruments. Noncurrent Receivables. The fair value of noncurrent receivables is based on anticipated cash flows which approximates carrying value. 60 Weighted average assumptions used to determine benefit obligations are as follows: December 31 2004 2003 Discount rate 6.00% 6.25% Rate of compensation increase 4.50 5.00 Year ended December 31 2004 2003 2002 Discount rate 6.25% 6.75% 7.25% Expected long-term return on plan assets 9.00 9.00 9.50 Rate of compensation increase 5.00 5.00 5.00 December 31 2004 2003 2002 Health care cost trend rate assumed for next year 8.0% 9.0% 11.0% Rate to which the cost trend rate gradually declines 5.0% 5.0% 5.0% Year that the rate reaches the rate at which it is assumed to remain 2009 2009 2008 Year ended December 31 Pension benefits Post- retirement benefits Subsidy receipts 2005 $ 700 $ 358 $ — 2006 700 350 15 2007 750 350 15 2008 750 350 15 2009 800 350 15 2010 through 2014 4,400 1,500 75 $8,100 $3,258 $135 2004 Carrying value Fair value 2003 Carrying value Fair value Cash and cash equivalents $ 457 $ 457 $ 576 $ 576 Short-term investments 6 6 30 30 Noncurrent receivables 18 18 23 23 Available-for-sale investments 527 527 639 639 Short-term debt 324 324 573 573 Commercial paper 630 630 — — Long-term debt 5,346 5,968 6,693 7,372 1% increase 1% decrease Effect on total of service and interest cost components $ 10 $ (9 ) Effect on postretirement benefit obligations 153 (137 ) Assumed health care cost trend rates have an effect on the amounts reported for the health care plan. A one-percentage- point change in these assumed rates would have the following effects: Asset category Policy range Plan assets at December 31 2004 2003 Ta rg e t % 2005 Equity securities 35–60% 56% 52% 53% Debt securities 30–55% 35 36 35 Real estate 5–15% 5 6 6 Other 0–15% 4 6 6 Total 100% 100% 100% Plan Assets X. Other Financial Instruments and Derivatives Cash Flows Assumptions