Equity in earnings of nonconsolidated affiliates increaseddeclined from $220 million in 2003 to $582 million in 2004. The increase was driven by substantially stronger results at2004 to $476 million in 2005. While improved earnings from UOP more than offset the decrease in reported earnings from EQUATE Petrochemical Company K.S.C., the OPTIMAL Group, Univation Technologies, LLC and UOP LLC. Equity (“EQUATE”) in 2005, equity earnings in 2004 also included the favorable impact of the recognition of investment tax allowances by one of the Corporation'sCorporation’s joint ventures.

On November 30, 2005, the Corporation completed the sale of its indirect 50 percent interest in UOP to a wholly owned subsidiary of Honeywell International, Inc. for a purchase price of $867 million, resulting in a pretax gain of $637 million in the fourth quarter of 2005.

Sundry income (expense)— – net includes a variety of income and expense items such as dividend income, the gain or loss on foreign currency exchange, commissions, charges for management services provided by Dow, and gains and losses on sales of investments and assets. Sundry income (expense) – net for 20042005 was net income of $145 million, compared with net expense of $70 million compared with netin 2004. Sundry income for 2005 included a $70 million pretax gain on the sale of a portion of the Corporation’s ownership interest in EQUATE (See Note F to the Consolidated Financial Statements), dividend income of $25approximately $118 million in 2003. Sundry income (expense) for 2004 was(including $86 million from Dow International Holdings Company and $29 million from Dow Chemical Canada Inc.) and lower than last year primarily due to higher commission expense on feedstock purchases resulting from commission rate changes implemented in the second half of 2003. Sundry income (expense) in 2003 included net gains of approximately $57 million associated with the sale of certain product lines of Amerchol Corporation, a wholly owned subsidiary, and other non-strategic assets.purchases.

Interest income for 20042005 was $8$29 million compared with $10$8 million in 2003.2004, reflecting the sizeable increase in the level of interest bearing assets during 2005. Interest expense and amortization of debt discount for 2004 was $93 million, a decrease of $202005 decreased $22 million compared with 2003, reflecting lower2004, as reduced levels of short-termlong-term debt throughoutwere achieved through the year.early extinguishment of approximately $436 million of debt, most of which occurred in the first half of 2005.

The provision for income taxes was $496 million in 2005 compared with $248 million in 2004 compared with $100 million in 2003. UCC's2004. UCC’s overall effective tax rate was 27.4 percent for 2005, compared with 26.5 percent for 2004, compared with 24.2 percent for 2003. UCC's2004. UCC’s effective tax rate fluctuates based on, among other factors, where income is earned, the level of after-tax income from joint ventures, and the level of income relative to available tax credits. The Corporation is included in Dow’s consolidated federal income tax group and consolidated income tax return. The underlying factors affecting UCC'sUCC’s overall effective tax rates are summarized in Note QO to the Consolidated Financial Statements.

OTHER MATTERS

Accounting Changes

See Note A to the Consolidated Financial Statements for a discussion of accounting changes and recently issued accounting pronouncements.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformityaccordance with GAAPaccounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make judgments, assumptions and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Note A to the Consolidated Financial Statements describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. Following are the Corporation'sCorporation’s critical accounting policies impacted by judgments, assumptions and estimates:

Litigation

The Corporation is subject to legal proceedings and claims arising out of the normal course of business. The Corporation routinely assesses the likelihood of any adverse judgments or outcomes to these matters, as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after thoughtful analysis of each known issue and an actuarial analysis of historical claims experience for incurred but not reported matters. The Corporation has an active risk management program consisting of numerous insurance policies secured from many carriers. These policies provide coverage that is utilized to minimize the impact, if any, of the legal proceedings. The required reserves may change in the future due to new developments in each matter. For further discussion, see Note J to the Consolidated Financial Statements.

10

---

Asbestos-Related Matters

The Corporation, and a former subsidiary, Amchem Products, Inc. ("Amchem"(“Amchem”), are and have been involved in a large number of asbestos-related suits filed primarily in state courts during the past three decades. Based on a study completed by Analysis, Research & Planning Corporation ("ARPC"(“ARPC”) in January 2003, the Corporation increased its December 31, 2002 asbestos-related liability for pending and future claims for the 15-year period ending in 2017 to $2.2 billion, excluding future defense and processing costs. The Corporation also increased the receivable for insurance recoveries related to its asbestos liability to $1.35 billion at December 31, 2002.

In November 2004, the Corporation requested ARPC to review the Corporation'sCorporation’s historical asbestos claim and resolution activity and determine the appropriateness of updating its January 2003 study. In January 2005, ARPC provided the Corporation with a report summarizing the results of its study.

Based on ARPC'sARPC’s January 2003 and January 2005 studies, the Corporation's recentCorporation’s asbestos litigation experience, and the uncertainties surrounding asbestos litigation and legislative reform efforts, management determined that no change to the accrual was required at December 31, 2004. Furthermore, based on

In November 2005, the low endCorporation requested ARPC to review the Corporation’s 2005 asbestos claim and resolution activity and determine the appropriateness of the range inupdating the January 2005 study. In response to that request, ARPC reviewed and analyzed data through October 31, 2005. In January 2006, ARPC stated that an update of the study would not provide a more likely estimate of future events than the recorded asbestos-related liability for pendingestimate reflected in its study of the previous year and, future claimstherefore, the estimate in that study remained applicable. Based on the Corporation’s own review of the asbestos claim and resolution activity and ARPC’s response, the Corporation determined that no change to the accrual was required at December 31, 2004 would be sufficient to resolve asbestos-related claims against UCC and Amchem into 2019.2005.

The Corporation'sCorporation’s asbestos-related liability for pending and future claims was $1.5 billion at December 31, 2005 and $1.6 billion at December 31, 2004 and $1.9 billion at December 31, 2003.2004. The Corporation'sCorporation’s receivable for insurance recoveries related to its asbestos liability was $535 million at December 31, 2005 and $712 million at December 31, 2004 and $1.0 billion at December 31, 2003.2004. In addition, the Corporation had receivables of $400 million at December 31, 2005 and $491 million at December 31, 2004 and $349 million at December 31, 2003 for insurance recoveries for defense and resolution costs.

The amounts recorded by the Corporation for the asbestos-related liability and related insurance receivable were based upon current, known facts. However, projecting future events, such as the number of new claims to be filed and/or received each year, the average cost of disposing of each such claim, coverage issues among insurers, and the continuing solvency of various insurance companies, as well as the numerous uncertainties surrounding asbestos litigation in the

United States, could cause the actual costs and insurance recoveries for the Corporation to be higher or lower than those projected or those recorded.

 

For additional information, see Legal Proceedings, Asbestos-Related Matters in Management'sManagement’s Discussion and Analysis of Financial Condition and Results of OperationsOperation, and Note J to the Consolidated Financial Statements.

Environmental Matters

The Corporation determines the costs of environmental remediation of its facilities and formerly owned facilities based on evaluations of current law and existing technologies. Inherent uncertainties exist in such evaluations primarily due to unknown conditions, changing governmental regulations and legal standards regarding liability, and evolving technologies. The recorded liabilities are adjusted periodically as remediation efforts progress or as additional technical or legal information becomes available. The Corporation had accrued obligations of $109$104 million at December 31, 2003, for environmental remediation and restoration costs, including $33 million for the remediation of Superfund sites. At December 31, 2004, the Corporation had accrued obligations of $104 million for environmental remediation and restoration costs, including $39 million for the remediation of Superfund sites. At December 31, 2005, the Corporation had accrued obligations of $87 million for environmental remediation and restoration costs, including $34 million for the remediation of Superfund sites. This is management'smanagement’s best estimate of the costs for remediation and restoration with respect to environmental matters for which the Corporation has accrued liabilities, although the ultimate cost with respect to these particular matters could range up to twice that amount. For further discussion, see Environmental Matters in Management'sManagement’s Discussion and Analysis of Financial Condition and Results of OperationsOperation and NoteNotes A and J to the Consolidated Financial Statements.

Pension and Other Postretirement Benefits

The amounts recognized in the consolidated financial statements related to pension and other postretirement benefits are determined from actuarial valuations. Inherent in these valuations are assumptions including expected return on plan assets, discount rates at which the liabilities could be settled at December 31, 2004,2005, rate of increase in future compensation levels, mortality rates and health care cost trend rates. These assumptions are updated annually and are disclosed in Note L to the Consolidated Financial Statements. In accordance with U.S. GAAP, actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, affect expense recognized and obligations recorded in future periods.

 

11

---

The Corporation determined the expected long-term rate of return on assets by performing a bottom-up analysis of historical and expected returns based on the strategic asset allocation and the underlying return fundamentals of each asset class. The Corporation'sCorporation’s historical experience with the pension fund asset performance and comparisons to expected returns of peer companies with similar fund assets arewere also considered. The long-term rate of return assumption used for determining net periodic pension expense for 20042005 was 98.75 percent. This assumption was reduced to 8.75 percentunchanged for determining 20052006 net periodic pension expense. The actual rate of return in 20042005 was 127.96 percent. Future actual pension income will depend on future investment performance, changes in future discount rates and various other factors related to the population of participants in the Corporation'sCorporation’s pension plans. A 25 basis point adjustment in the long-term return on assets assumption changes total pension expense for 20052006 by approximately $10 million.

The Corporation bases the determination of pension expense or income on a market-related valuation of plan assets, which reduces year-to-year volatility. This market-related valuation recognizes investment gains or losses over a five-year period from the year in which they occur. Investment gains or losses for this purpose represent the difference between the expected return calculated using the market-related value of plan assets and the actual return based on the market value of plan assets. Since the market-related value of plan assets recognizes gains or losses over a five-year period, the future value of plan assets will be impacted when previously deferred gains or losses are recorded. Over the life of the plan, both gains and losses have been recognized and amortized. For the year endingAt December 31, 2004, $1962005, $59 million of net losses remain to be recognized in the calculation of the market-related value of plan assets. These net losses will result in increases in future pension expense as they are recognized in the market-related value of assets.assets and are a component of the unrecognized net loss of $789 million shown under “Funded status and net amounts recognized” in the table entitled “Change in Projected Benefit Obligations, Plan Assets and Funded Status of all Significant Plans” included in Note L to the Consolidated Financial Statements. The $730 million of remaining unrecognized net loss represents changes in plan experience and actuarial assumptions. The increase or decrease in the market-related value of assets due to the recognition of prior gains and losses is presented in the following table:

 

Increase (Decrease) in Market-Related Asset Value
due to Recognition of Prior Asset Gains and Losses

In millions
2006		$	(83	)
2007		43
2008		(5		)
2009		(14		)
Total		$	(59	)

The discount rate utilized for determining future pension obligations is based on a broad-based index of high quality bonds receiving an AA- or better rating by a recognized rating agency and matched to the future expected cash flows by half-year periods by plan. The resulting discount rate decreased from 6.25 percent at December 31, 2003, to 5.875 percent at December 31, 2004.2004, to 5.65 percent at December 31, 2005. A 25 basis point adjustment in the discount rate assumption changes total pension expense for 20052006 by approximately $3$7 million, with an immaterial change on the other postretirement benefit expense due to defined dollar limits (caps).

 

For 2005,2006, the Corporation maintained its assumption for the long-term rate of increase in compensation levels of

4.5 percent. Since 2002, the Corporation has used a generationgenerational mortality table to determine the duration of its pension and other postretirement obligation.obligations.

 

Based on the revised pension assumptions and changes in the market-related value of assets due to the recognition of prior asset gains and losses, the Corporation expects to record $13$25 million less in income for pension and other postretirement benefits in 20052006 than it did in 2004.2005.

 

The value of the qualified plan assets increased from $3.7totaled $3.89 billion at December 31, 2003, to $3.9 billion at December 31, 2004.2005, an increase of $30 million over the prior year. The investment performance increaseddecline in the assumed discount rate reduced the funded status of the qualified plans,plan, net of benefit obligations, by $92$20 million from December 31, 20032004 to December 31, 2004. This increase was somewhat offset by a decline in the assumed discount rate.2005. For 2005,2006, the Corporation does not expect to make cash contributions to its pension and other postretirement benefit plans.

12

---

Income Taxes

Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities, applying enacted tax rates expected to be in effect for the year in which the differences are expected to reverse. Based on the evaluation of available evidence, both positive and negative, the Corporation recognizes future tax benefits, such as net operating loss carryforwards and tax credit carryforwards, to the extent that realizing these benefits is considered more likely than not.

At December 31, 2004,2005, the Corporation had a net deferred tax assetliability balance of $523$31 million and no valuation allowance.deferred tax assets for tax loss and tax credit carryforwards of $144 million, of which less than $1 million is subject to expiration in the years 2006-2010. In order to realize these deferred tax assets for tax loss and tax credit carryforwards, the Corporation needs taxable income of approximately $412 million across multiple jurisdictions. The taxable income needed to realize the deferred tax assets for tax loss and tax credit carryforwards that are subject to expiration between 2006-2010 is less than $1 million. In evaluating the ability to realize its deferred tax assets, the Corporation relied principally on forecasted taxable income using historical and projected future operating results, the reversal of existing temporary differences and the availability of tax planning strategies.

 At December 31, 2004, the Corporation had deferred tax assets for tax loss and tax credit carryforwards of $547 million, $1 million of which is subject to expiration in the years 2005-2009. In order to realize these deferred tax assets for tax loss and tax credit carryforwards, the Corporation needs taxable income of approximately $1.5 billion across multiple jurisdictions. The taxable income needed to realize the deferred tax assets for tax loss and tax credit carryforwards that are subject to expiration between 2005-2009 is approximately $5 million.

The Corporation accrues for tax contingencies when it is probable that a liability to a taxing authority has been incurred and the amount of the contingency can be reasonably estimated, based on past experience. The tax contingency reserve is adjusted for changes in circumstances and additional uncertainties, such as significant amendments to existing tax law. At December 31, 2004,2005, the Corporation had a tax contingency reserve for both domestic and foreign issues of $221$156 million. For additional information, see Note QO to the Consolidated Financial Statements.

Environmental Matters

Environmental Policies

Prior to the Dow merger, theThe Corporation and Dow both were RESPONSIBLE CARE companies,is committed to the Guiding Principles of RESPONSIBLE CARE,Responsible Care®, to environmental, health and safety ("(“EH&S"&S”) performance improvement and to public accountability. After the Dow merger, Dow'sDow’s EH&S management system ("EMS"(“EMS”) and EH&S 2005 Goals were implemented at all UCC sites in order to minimize environmental risks and impacts, both past and future.

        Dow'sDow’s EH&S 2005 Goals, initiated in 1996, include reducing leaks, spills, fires, explosions, work-related injuries and transportation incidents by 90 percent, and reducing chemical emissions, waste and wastewater by 50 percent. Dow'sDow’s EMS defines for the businesses the "who,“who, what, when and how"how” needed to achieve the policies, requirements, performance objectives, leadership expectations and public commitments. EMS is also designed to minimize the long-term cost of environmental protection and to comply with applicable laws and regulations. Security aspects of EMS were strengthened to require site vulnerability assessments to ensure appropriate safeguards to protect employees and physical assets in a post-September 11^th world. Furthermore, EMS is integrated into a company-wide Management System for EH&S, Operations, Quality and Human Resources, including implementation of the global EH&S Work Process to improve EH&S performance and to ensure ongoing compliance worldwide.

UCC first works to eliminate or minimize the generation of waste and emissions at the source through research, process design, plant operations and maintenance. Next, UCC finds ways to reuse and recycle materials. Finally, unusable or non-recyclable hazardous waste is treated before disposal to eliminate or reduce the hazardous nature and volume of the waste. Treatment may include destruction by chemical, physical, biological or thermal means. Disposal of waste materials in landfills is considered only after all other options have been thoroughly evaluated. UCC has specific requirements for wasteswaste that areis transferred to non-UCC facilities, including the periodic auditing of these facilities.

In 2005, the next generation of Dow’s 10-year goals were developed, which will provide continuity to the first set of goals, while also addressing a broader set of challenges. The 2015 Sustainability Goals will set the standard for sustainability in the industry by focusing on improvements in local corporate citizenship and product stewardship, and actively pursuing methods to reduce the Corporation’s environmental impact.

Chemical Security

Growing public and political attention has been placed on protecting U.S. critical infrastructure, including the chemical industry, from security threats. Terrorist attacks and natural disasters have increased concern about the security of chemical production and distribution. The focus on security is not new to UCC and UCC continues to improve its security plans, placing emphasis on the safety of UCC communities and people by being prepared to meet risks at any level and to address both internal and external identifiable risks. UCC’s security plans also are developed to avert interruptions of normal business work operations which could materially and adversely affect the Corporation’s results of operations, liquidity and financial condition.

UCC is a Responsible Care® company and adheres to the Responsible Care® Security Code that requires all aspects of
security – including facility, transportation, and cyberspace – be assessed and gaps addressed. Through global implementation

13