25. Retirement benefit and other post-retirement obligations

Background

The Group operates a number of defined benefit and defined contribution retirement plans throughout the world.

The largest plan is the Pearson Group Pension Plan (UK Group plan) in the UK, which is sectionalised to provide both defined benefit and defined contribution pension benefits. The defined benefit section was closed to new members from 1 November 2006. The defined contribution section, opened in 2003, is open to new and existing employees. Finally, there is a separate section within the UK Group plan set up for auto-enrolment. The defined benefit section of the UK Group plan is a final salary pension plan which provides benefits to members in the form of a guaranteed level of pension payable for life. The level of benefits depends on the length of service and final pensionable pay. The UK Group plan is funded with benefit payments from trustee-administered funds. The UK Group plan is administered in accordance with the Trust Deed and Rules in the interests of its beneficiaries by Pearson Group Pension Trustee Limited.

At 31 December 2017, the UK Group plan had approximately 24,000 members, analysed in the following table:


All figures in %	Active		Deferred		Pensioners		Total
Defined benefit		1		26		35		62
Defined contribution		8		30		—		38

Total		9		56		35		100

The other major defined benefit plans are based in the US. These are also final salary pension plans which provide benefits to members in the form of a guaranteed pension payable for life, with the level of benefits dependent on length of service and final pensionable pay. The majority of the US plans are funded.

The Group also has several post-retirement medical benefit plans (PRMBs), principally in the US. PRMBs are unfunded but are accounted for and valued similarly to defined benefit pension plans.

The defined benefit schemes expose the Group to actuarial risks, such as life expectancy, inflation risks, and investment risk including asset volatility and changes in bond yields. The Group is not exposed to any unusual, entity-specific or plan-specific risks.

The defined contribution section of the UK Group plan operates a Reference Scheme Test (RST) pension underpin for its members. Where a member’s fund value is insufficient to purchase the RST pension upon retirement, the UK Group plan is liable for the shortfall to cover the member’s RST pension. During the year, the UK Group plan revised its approach to securing the RST underpin by converting a member’s fund value into a pension in the UK Group plan rather than purchasing an annuity with an insurer. A liability of £32m (2016: £181m) in respect of the underpin is included in the UK Group plan’s defined benefit obligation, calculated as the present value of projected payments less the fund value. The UK Group plan’s conversion factors are lower than the respective insurer annuity values and this has driven a reduction in the underpin liability, resulting in an actuarial gain through other comprehensive income and an increase in the surplus at 31 December 2017. From 1 January 2018, members who have sufficient funds to purchase an RST pension will be able to convert their fund value into a pension in the UK Group plan as an alternative to purchasing an annuity with an insurer. The Group does not recognise the assets and liabilities for members of the defined contribution section of the UK Group plan whose fund values are expected to be sufficient to purchase an RST pension without assistance from the UK Group plan. The defined contribution section of the UK Group plan had gross assets of £442m at 31 December 2017.

Assumptions

The principal assumptions used for the UK Group plan and the US PRMB are shown below. Weighted average assumptions have been shown for the other plans, which primarily relate to US pension plans.


	2017						2016						2015
All figures in %	UK Group plan		Other plans		PRMB		UK Group plan		Other plans		PRMB		UK Group plan		Other plans		PRMB
Inflation		3.2		1.6		1.5		3.3		1.6		1.5		3.1		2.5		2.5
Rate used to discount plan liabilities		2.5		3.0		3.0		2.5		3.8		3.9		3.7		4.0		4.0
Expected rate of increase in salaries		3.7		3.0		3.0		3.8		3.0		3.0		3.6		3.0		3.0
Expected rate of increase for pensions in payment and deferred pensions		2.1 to 5.1		—		—		2.2 to 5.1		—		—		1.9 to 5.1		—		—
Initial rate of increase in healthcare rate		—		—		6.5		—		—		6.8		—		—		7.0
Ultimate rate of increase in healthcare rate		—		—		5.0		—		—		5.0		—		—		5.0

The UK discount rate is based on corporate bond yields adjusted to reflect the duration of liabilities. In 2017, the Group revised the portfolio of corporate bonds used to exclude bonds with an implicit government guarantee. Under the previous methodology, the 2017 UK discount rate would have been lower by around 0.1%.

The US discount rate is set by reference to a US bond portfolio matching model.

The inflation rate for the UK Group plan of 3.2% reflects the RPI rate. In line with changes to legislation in 2010, certain benefits have been calculated with reference to CPI as the inflationary measure and in these instances a rate of 2.2% has been used.

The expected rate of increase in salaries has been set at 3.7% for 2017 with a short-term assumption of 2.0% for three years.

For the UK plan, the mortality base table assumptions have been updated and are derived from the SAPS S2 for males and females, adjusted to reflect the observed experience of the plan, with CMI model improvement factors. A 1.5% long-term rate improvement on the CMI model is applied for both males and females.

For the US plans, the mortality table (RP – 2017) and 2017 improvement scale (MP – 2017) with generational projection for male and female annuitants has been adopted.

Using the above tables, the remaining average life expectancy in years of a pensioner retiring at age 65 on the balance sheet date for the UK Group plan and US plans is as follows:

All figures in years

2017

2016

2017

2016

Male

23.6

23.5

20.8

21.2

Female

25.7

25.6

22.8

23.2

The remaining average life expectancy in years of a pensioner retiring at age 65, 20 years after the balance sheet date, for the UK and US Group plans is as follows:

All figures in years

2017

2016

2017

2016

Male

25.7

25.5

22.5

22.9

Female

27.9

27.8

24.4

24.9

Although the Group anticipates that plan surpluses will be utilised during the life of the plan to address member benefits, the Group recognises its pension surplus in full in respect of the UK Group plan on the basis that it is management’s judgement that there are no substantive restrictions on the return of residual plan assets in the event of a winding up of the plan after all member obligations have been met.

The amounts recognised in the income statement are as follows:


	2017
All figures in £ millions	UK Group plan			Defined benefit other			Sub-total			Defined contribution		PRMB			Total
Current service cost		8			1			9			57		(1	)		65
Administration expenses		9			1			10			—		—			10

Total operating expense		17			2			19			57		(1	)		75

Interest on plan assets		(84	)		(5	)		(89	)		—		—			(89	)
Interest on plan liabilities		77			7			84			—		2			86

Net finance (income)/expense		(7	)		2			(5	)		—		2			(3	)

Net income statement charge		10			4			14			57		1			72


	2016
All figures in £ millions	UK Group plan			Defined benefit other			Sub-total			Defined contribution		PRMB			Total
Current service cost		8			2			10			67		—			77
Curtailments		—			—			—			—		(2	)		(2	)
Administration expenses		6			—			6			—		—			6

Total operating expense		14			2			16			67		(2	)		81

Interest on plan assets		(104	)		(6	)		(110	)		—		—			(110	)
Interest on plan liabilities		89			7			96			—		3			99

Net finance (income)/expense		(15	)		1			(14	)		—		3			(11	)

Net income statement charge		(1	)		3			2			67		1			70


	2015
All figures in £ millions	UK Group plan			Defined benefit other			Sub-total			Defined contribution		PRMB		Total
Current service cost		20			2			22			74		—		96
Curtailments		(3	)		—			(3	)		—		—		(3	)
Administration expenses		5			—			5			—		—		5

Total operating expense		22			2			24			74		—		98

Interest on plan assets		(98	)		(5	)		(103	)		—		—		(103	)
Interest on plan liabilities		90			7			97			—		2		99

Net finance (income)/expense		(8	)		2			(6	)		—		2		(4	)

Net income statement charge		14			4			18			74		2		94

Operating expenses in 2015 included a charge of £5m for defined benefit schemes and a charge of £8m for defined contribution schemes in respect of discontinued operations. There were no discontinued operations in 2016 or 2017.

The amounts recognised in the balance sheet are as follows:


	2017												2016
All figures in £ millions	UK Group plan			Other funded plans			Other unfunded plans			Total			UK Group plan			Other funded plans			Other unfunded plans			Total
Fair value of plan assets		3,337			155			—			3,492			3,339			158			—			3,497
Present value of defined
benefit obligation		(2,792	)		(161	)		(20	)		(2,973	)		(3,181	)		(183	)		(22	)		(3,386	)

Net pension asset/(liability)		545			(6	)		(20	)		519			158			(25	)		(22	)		111

Other post-retirement medical benefit obligation											(67	)											(77	)
Other pension accruals											(11	)											(15	)

Net retirement benefit asset											441												19

Analysed as:
Retirement benefit assets											545												158
Retirement benefit obligations											(104	)											(139	)

The following gains/(losses) have been recognised in other comprehensive income:


All figures in £ millions	2017		2016			2015
Amounts recognised for defined benefit plans		175		(277	)		104
Amounts recognised for post-retirement medical benefit plans		—		9			6

Total recognised in year		175		(268	)		110

The fair value of plan assets comprises the following:


	2017						2016
All figures in %	UK Group plan		Other funded plans		Total		UK Group plan		Other funded plans		Total
Insurance		29		—		29		—		—		—
Equities		1		1		2		2		1		3
Bonds		—		3		3		9		1		10
Property		8		—		8		8		—		8
Pooled asset investment funds		44		—		44		67		—		67
Other		14		—		14		12		—		12

The plan assets do not include any of the Group’s own financial instruments, or any property occupied by the Group. The table below further disaggregates the UK Group plan assets into additional categories and those assets which have a quoted market price in an active market and those that do not:


	2017				2016
All figures in %	Quoted market price		No quoted market price		Quoted market price		No quoted market price
Insurance		29		—		—		—
Non-UK equities		—		2		—		3
Fixed-interest securities		3		—		10		—
Property		—		8		—		8
Pooled asset investment funds		44		—		67		—
Other		—		14		—		12

Total		76		24		77		23

The liquidity profile of the UK Group plan assets is as follows:


All figures in %	2017		2016
Liquid – call <1 month		50		75
Less liquid – call 1-3 months		—		—
Illiquid – call >3 months		50		25

Changes in the values of plan assets and liabilities of the retirement benefit plans are as follows:


	2017									2016
All figures in £ millions	UK Group plan			Other plans			Total			UK Group plan			Other plans			Total
Fair value of plan assets
Opening fair value of plan assets		3,339			158			3,497			2,803			135			2,938
Exchange differences		—			(8	)		(8	)		—			24			24
Interest on plan assets		84			5			89			104			6			110
Return on plan assets excluding interest		(140	)		10			(130	)		445			8			453
Contributions by employer		234			8			242			99			2			101
Benefits paid		(188	)		(18	)		(206	)		(112	)		(17	)		(129	)
Other		8			—			8			—			—			—

Closing fair value of plan assets		3,337			155			3,492			3,339			158			3,497

Present value of defined benefit obligation
Opening defined benefit obligation		(3,181	)		(205	)		(3,386	)		(2,466	)		(175	)		(2,641	)
Exchange differences		—			13			13			—			(32	)		(32	)
Current service cost		(8	)		(1	)		(9	)		(8	)		(2	)		(10	)
Administration expenses		(9	)		(1	)		(10	)		(6	)		—			(6	)
Interest on plan liabilities		(77	)		(7	)		(84	)		(89	)		(7	)		(96	)
Actuarial gains/(losses) – experience		126			6			132			12			—			12
Actuarial gains/(losses) – demographic		133			1			134			(47	)		2			(45	)
Actuarial gains/(losses) – financial		44			(5	)		39			(689	)		(8	)		(697	)
Contributions by employee		—			—			—			—			—			—
Other		(8	)		—			(8	)		—			—			—
Benefits paid		188			18			206			112			17			129

Closing defined benefit obligation		(2,792	)		(181	)		(2,973	)		(3,181	)		(205	)		(3,386	)

The weighted average duration of the defined benefit obligation is 16.9 years for the UK and 8.1 years for the US.

Changes in the value of the US PRMB are as follows:


All figures in £ millions	2017			2016
Opening defined benefit obligation		(77	)		(76	)
Exchange differences		5			(14	)
Current service cost		1			—
Curtailments		—			2
Interest on plan liabilities		(2	)		(3	)
Actuarial gains/(losses) – experience		1			8
Actuarial gains/(losses) – demographic		1			2
Actuarial gains/(losses) – financial		(2	)		(1	)
Benefits paid		6			5

Closing defined benefit obligation		(67	)		(77	)

Funding

The UK Group plan is self-administered with the plan’s assets being held independently of the Group in trust. The trustee of the plan is required to act in the best interest of the plan’s beneficiaries. The most recent triennial actuarial valuation for funding purposes was completed as at 1 January 2015 and this valuation revealed a technical provisions funding shortfall of £27m which was eliminated by contributions paid during 2015.

As a consequence of the disposal of the FT Group, an agreement has been made between Pearson and the plan trustee to accelerate the funding of the plan. As a result, the plan is expected to be fully funded on a ‘self-sufficiency’ basis by 2019, inclusive of £202m paid in 2017 in relation to the Penguin Random House merger in 2013. This is a much higher level of funding than technical provisions. As a result, the plan expects to be able to provide benefits (in accordance with the plan rules) with a very low level of reliance on future funding from Pearson. A commitment has also been made to maintain that level of funding in future years.

Assets of the plan are divided into two elements: matching assets, which are assets that produce cash flows that can be expected to match the cash flows for a proportion of the membership, and include a liability-driven investment mandate (UK bonds, interest rate/inflation swaps and other derivative instruments), inflation-linked property and infrastructure; and return seeking assets, which are assets invested with a longer-term horizon to generate the returns needed to provide the remaining expected cash flows for the beneficiaries, and include diversified growth funds, property and alternative asset classes. The plan’s long-term investment strategy allocates 85% to matching assets and 15% to return seeking assets.

In October 2017, the UK Group plan purchased pensioner buy-in policies with both Aviva and Legal & General totalling £1.2bn. The buy-ins cover around a third of its total liabilities and are split equally between the two insurers. The buy-ins transfer significant longevity risk to Aviva and Legal & General, reducing the pension risks being underwritten by the Group and providing additional security for members.

Regular contributions to the plan in respect of the defined benefit sections are estimated to be £6m for 2018.

Sensitivities

The effect of a one percentage point increase and decrease in the discount rate on the defined benefit obligation and the total pension expense is as follows:


	2017
All figures in £ millions	1% increase			1% decrease
Effect:
(Decrease)/increase in defined benefit obligation – UK Group plan		(423	)		575
(Decrease)/increase in defined benefit obligation – US plan		(14	)		16

The effect of members living one year more or one year less on the defined benefit obligation is as follows:


	2017
All figures in £ millions	One year increase		One year decrease
Effect:
Increase/(decrease) in defined benefit obligation – UK Group plan		145		(152	)
Increase/(decrease) in defined benefit obligation – US plan		8		(9	)

The effect of a half percentage point increase and decrease in the inflation rate is as follows:


	2017
All figures in £ millions	0.5% increase		0.5% decrease
Effect:
Increase/(decrease) in defined benefit obligation – UK Group plan		144		(132	)
Increase/(decrease) in defined benefit obligation – US plan		—		—

The above sensitivity analyses are based on a change in an assumption while holding all other assumptions constant, although in practice this is unlikely to occur and changes in some assumptions may be correlated. When calculating these sensitivities, the same method has been applied to calculate the defined benefit obligation as has been applied when calculating the liability recognised in the balance sheet. This methodology is the same as prior periods.