24 Employee benefits

Retirement benefit obligations

The Group operates a number of retirement benefit plans throughout the world, the principal ones being in the UK and US. The major plans are self-administered with the plans' assets being held independently of the Group. Retirement benefit costs are assessed in accordance with the advice of independent qualified actuaries. The UK Group plan is a hybrid plan with both defined benefit and defined contribution sections but, predominantly, consisting of defined benefit liabilities. There are a number of defined contribution plans, principally overseas.

The most recent actuarial valuation of the UK Group plan was completed as at 1 January 2006.

The principal assumptions used for the UK Group plan are shown below. Weighted average assumptions have been shown for the other plans.

%	2006 UK Group plan	2006 Other plans	2005 UK Group plan	2005 Other plans
Inflation	3.00	2.91	2.80	2.95
Expected rate of increase in salaries	4.70	4.37	4.50	4.43
Expected rate of increase for pensions in payment and deferred pensions	2.10 to 4.60	–	2.50 to 4.00	–
Rate used to discount plan liabilities	5.20	5.70	4.85	5.54
Expected return on assets	6.40	7.18	6.40	7.31

Assumptions regarding future mortality experience are set based on advice, published statistics and experience in each territory. In 2006, the Group used the PMFA92 (medium-cohort) series mortality tables for the UK Group plan modified for age-rating adjustments to recalibrate the tables against observed experience of the plan, and allowing for the future improvement effect from the medium cohort approach.

The remaining average life expectancy in years of a pensioner retiring at age 65 on the balance sheet date is as follows for the UK Group plan:

The remaining average life expectancy in years of a pensioner retiring at age 65 on the balance
sheet date is as follows for the UK Group plan:

	2006	2005
Male	20.9	19.5
Female	21.3	21.5

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

The remaining average life expectancy in years of a pensioner retiring at age 65 on the balance
sheet date is as follows for the UK Group plan:

	2006	2005
Male	22.2	20.2
Female	22.5	22.1

The amounts recognised in the income statement are as follows:

The amounts recognised in the income statement are as follows:

All figures in £ millions	UK Group plan	Defined benefit other	Sub total	Defined contribution	2006 Total
Current service cost	27	2	29	36	65
Total operating costs	27	2	29	36	65
Expected return on plan assets	(85)	(7)	(92)	–	(92)
Interest on pension scheme liabilities	78	7	85	–	85
Net finance income	(7)	–	(7)	–	(7)
Net income statement charge	20	2	22	36	58
Actual return on plan assets	153	13	166	–	166

All figures in £ millions	UK Group plan	Defined benefit other	Sub total	Defined contribution	2005 Total
Current service cost	25	2	27	35	62
Curtailments	–	(2)	(2)	–	(2)
Total operating costs	25	–	25	35	60
Expected return on plan assets	(75)	(6)	(81)	–	(81)
Interest on pension scheme liabilities	79	6	85	–	85
Net finance costs	4	–	4	–	4
Net income statement charge	29	–	29	35	64
Actual return on plan assets	214	7	221	–	221

The total operating charge is included in administrative and other expenses.

The amounts recognised in the balance sheet are as follows:

24 Employee benefits continued
The amounts recognised in the balance sheet are as follows:

All figures in £ millions	2006 UK Group plan	2006 Other funded plans	2006 Other unfunded plans	2006 Total	2005 UK Group plan	2005 Other funded plans	2005 Other unfunded plans	2005 Total
Fair value of plan assets	1,528	105	–	1,633	1,390	110	–	1,500
Present value of defined benefit obligation	(1,683)	(115)	(12)	(1,810)	(1,661)	(131)	(11)	(1,803)
Net pension liability	(155)	(10)	(12)	(177)	(271)	(21)	(11)	(303)
Other post-retirement medical benefit obligation				(48)				(60)
Other pension accruals				(25)				(26)
Total retirement benefit obligations				(250)				(389)

The following gains/(losses) have been recognised in the statement of recognised income and expense:

The following gains/(losses) have been recognised in the statement of recognised income
and expense:

All figures in £ millions	2006	2005
Amounts recognised for defined benefit plans	102	21
Amounts recognised for post-retirement medical benefit plans	5	5
Total recognised in year	107	26
Cumulative amounts recognised	44	(63)

The fair value of plan assets comprises the following:

The fair value of plan assets comprises the following:

%	2006 UK Group plan	2006 Other funded plans	2006 Total	2005 UK Group plan	2005 Other funded plans	2005 Total
Equities	46.6	3.9	50.5	47.4	4.3	51.7
Bonds	23.8	2.1	25.9	24.7	2.0	26.7
Properties	9.2	–	9.2	8.9	–	8.9
Other	14.0	0.4	14.4	11.7	1.0	12.7

The plan assets do not include any of the Group's own financial instruments, nor any property occupied by the Group.

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

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

All figures in £ millions	2006 UK Group plan	2006 Other	2006 Total	2005 UK Group plan	2005 Other	2005 Total
Fair value of plan assets
Opening fair value of plan assets	1,390	110	1,500	1,198	82	1,280
Exchange differences	–	(12)	(12)	–	9	9
Expected return on plan assets	85	7	92	75	6	81
Actuarial gains and losses	68	6	74	139	1	140
Contributions by employer	43	2	45	35	10	45
Contributions by employee	7	–	7	6	–	6
Benefits paid	(65)	(8)	(73)	(63)	(6)	(69)
Acquisition through business combination	–	–	–	–	8	8
Closing fair value of plan assets	1,528	105	1,633	1,390	110	1,500
Present value of defined benefit obligation
Opening defined benefit obligation	(1,661)	(142)	(1,803)	(1,502)	(113)	(1,615)
Exchange differences	–	15	15	–	(12)	(12)
Current service cost	(27)	(2)	(29)	(25)	(2)	(27)
Curtailment	–	–	–	–	2	2
Interest cost	(78)	(7)	(85)	(79)	(6)	(85)
Actuarial gains and losses	25	3	28	(112)	(7)	(119)
Contributions by employee	(7)	–	(7)	(6)	–	(6)
Benefits paid	65	8	73	63	6	69
Acquisition through business combination	–	(2)	(2)	–	(10)	(10)
Closing defined benefit obligation	(1,683)	(127)	(1,810)	(1,661)	(142)	(1,803)

The history of the defined benefit plans is as follows:

The history of the defined benefit plans

All figures in £ millions	2006	2005	2004	2003
Fair value of plan assets	1,633	1,500	1,280	1,164
Present value of defined benefit obligation	(1,810)	(1,803)	(1,615)	(1,454)
Net pension liability	(177)	(303)	(335)	(290)
Experience adjustments on plan assets	74	140	67	88
Experience adjustments on plan liabilities	28	(119)	(127)	(113)

The expected rates of return on categories of plan assets are determined by reference to relevant indices. The overall expected rate of return is calculated by weighting the individual rates in accordance with the anticipated balance in the plan's investment portfolio.

The Group expects to contribute approximately £150m to its defined benefit plans in 2007, which includes an additional contribution of £100m to the UK Group plan.

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

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

All figures in £ millions	2006 1% increase	2006 1% decrease
Effect on:
(Decrease)/increase in defined benefit obligation	(242)	297

Other post-retirement obligations

The Group operates a number of post-retirement medical benefit plans, principally in the US. These plans are unfunded. The method of accounting and the frequency of valuations are similar to those used for defined benefit pension plans.

The principal assumptions used are shown below:

The principal assumptions used are shown below:

%	2006	2005
Inflation	3.00	3.00
Initial rate of increase in healthcare rates	10.00	10.00
Ultimate rate of increase in healthcare rates	5.00	5.00
Rate used to discount scheme liabilities	5.85	5.60

The amounts recognised in the income statement are as follows:

The amounts recognised in the income statement are as follows:

All figures in £ millions	2006	2005
Current service cost	1	1
Past service cost	(2)	–
Total operating (income)/costs	(1)	1
Interest cost	3	3
Net income statement charge	2	4

The current and past service costs have been included in administrative and other expenses.

All figures in £ millions	2006	2005
Opening defined benefit obligation	(60)	(58)
Exchange differences	8	(7)
Reclassifications	(3)	–
Current service cost	(1)	(1)
Past service cost	2	–
Interest cost	(3)	(3)
Benefits paid	4	4
Actuarial gains and losses	5	5
Closing defined benefit obligation	(48)	(60)

The effect of a one percentage point increase and decrease in the assumed medical cost trend rates is as follows:

The effect of a one percentage point increase and decrease in the assumed medical cost trend rates is as follows:

All figures in £ millions	2006 1% increase	2006 1% decrease	2005 1% increase	2005 1% decrease
Effect on:
Increase/(decrease) of aggregate of service cost and interest cost	0.1	(0.1)	0.2	(0.2)
(Decrease)/increase in defined benefit obligation	(4.7)	5.1	(4.7)	4.1

Share-based payments

The Group recognised the following charges in the income statement in respect of its equity-settled share-based payment plans:

Share-based payments
The Group recognised the following charges in the income statement in respect of its
equity-settled share-based payment plans:

All figures in £ millions	2006	2005
Pearson plans	18	13
IDC plans	7	10
Total share-based payment costs	25	23

The Group operates the following equity-settled employee option and share plans:

Worldwide Save for Shares Plan - Since 1994, the Group has operated a Save-As-You-Earn plan for UK employees. In 1998, the Group introduced a Worldwide Save for Shares Plan.Under these plans, employees can save a portion of their monthly salary over periods of three, five or seven years. At the end of this period, the employee has the option to purchase ordinary shares with the accumulated funds at a purchase price equal to 80% of the market price prevailing at the time of the commencement of the employee's participation in the plan. Options that are not exercised within six months of the third, fifth or seventh anniversary after grant lapse unconditionally.

Employee Stock Purchase Plan - In 2000, the Group established an Employee Stock Purchase Plan which allows all employees in the US to save a portion of their monthly salary over six month periods. At the end of the period, the employee has the option to purchase ADRs with their accumulated funds at a purchase price equal to 85% of the lower of the market price prevailing at the beginning or end of the period.

Long-Term Incentive Plan - This plan was introduced in 2001 and renewed in 2006 and consists of two parts: share options and/or restricted shares.

Options were granted under this plan in 2001 based on a pre-grant earnings per share growth test and are not subject to further performance conditions on exercise. The options became exercisable in tranches and lapse if they remain unexercised at the tenth anniversary of the date of grant.

The vesting of restricted shares is normally dependent on continuing service and/or upon the satisfaction of corporate performance targets over a three-year period. These targets may be based on market and/or nonmarket performance criteria. Restricted shares awarded to senior management in October 2006 vest dependent on relative shareholder return, return on invested capital and a combination of earnings per share growth. The award was split equally across all three measures. Other restricted shares awarded in 2006 vest depending on continuing service over a three-year period.

Annual Bonus Share Matching Plan - This plan permits executive directors and senior executives around the Group to invest up to 50% of any after tax annual bonus in Pearson shares. If these shares are held more than three years and the Group meets an earnings per share growth target, the Company will match them on a gross basis of up to one share for every one held after five years.

In addition to the above, share options remain outstanding under Executive Share Option, Reward and Special Share Option Plans. These are legacy plans which were replaced with the introduction of the Long-Term Incentive Plan in 2001.

The number and weighted average exercise prices of share options granted under the Group's plans are as follows:

The number and weighted average exercise prices of share options granted under the Group’s plans are
as follows:

	2006 Number of share options 000s	2006 Weighted average exercise price £	2005 Number of share options 000s	2005 Weighted average exercise price £
Outstanding at beginning of year	21,677	13.15	26,179	13.62
Granted during the year	837	6.30	606	4.92
Exercised during the year	(1,396)	5.36	(324)	6.01
Forfeited during the year	(1,828)	15.39	(4,352)	15.75
Expired during the year	(429)	6.72	(432)	9.17
Outstanding at end of year	18,861	13.36	21,677	13.15
Options exercisable at end of year	15,595	14.14	17,420	13.90

Options were exercised regularly throughout the year. The weighted average share price during the year was £7.45 (2005: £6.52). Early exercises arising from redundancy, retirement or death are treated as an acceleration of vesting and the Group therefore recognises in the income statement the amount that otherwise would have been recognised for services received over the remainder of the original vesting period.

The options outstanding at the end of the year have weighted average remaining contractual lives and exercise prices as follows:

The options outstanding at the end of the year have weighted average remaining contractual
lives and exercise prices as follows:

Range of exercise prices £	2006 Number of share options 000s	2006 Weighted average contractual life Years	2005 Number of share options 000s	2005 Weighted average contractual life Years
0 – 5	1,649	1.94	2,773	2.32
5 – 10	5,254	3.85	5,555	4.57
10 – 15	7,638	3.63	8,237	4.64
15 – 20	1,050	2.88	1,168	3.81
20 – 25	424	3.19	930	3.80
>25	2,846	3.22	3,014	4.22
	18,861	3.42	21,677	4.19

In 2006 and 2005 options were granted under the Worldwide Save for Shares Plan. The weighted average estimated fair value for the options granted was calculated using a Black-Scholes option pricing model.

The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:

The weighted average estimated fair values and the inputs into the
Black-Scholes model are as follows:

	2006 Weighted average	2005 Weighted average
Fair value	£1.92	£2.41
Weighted average share price	£7.66	£6.54
Weighted average exercise price	£6.30	£5.08
Expected volatility	23.12%	35.47%
Expected life	4.0 years	4.1 years
Risk free rate	4.42%	4.48%
Expected dividend yield	3.52%	3.93%
Forfeiture rate	5.0%	6.3%

The expected volatility is based on the historic volatility of the Company's share price over the previous three to seven years depending on the vesting term of the options.

The following shares were granted under restricted share arrangements:

The following shares were granted under restricted share arrangements:

	2006 Number of shares 000s	2006 Weighted average fair value £	2005 Number of shares 000s	2005 Weighted average fair value £
Annual Bonus Share Matching Plan	90	6.27	71	5.57
Long-Term Incentive Plan	3,585	6.96	3,987	5.05

In 2005, the fair value of restricted shares awarded under the Annual Bonus Share Matching Plan and the Long-Term Incentive Plan was determined using a Black-Scholes model to reflect dividends foregone using a dividend yield of 3.85%. From 2006 onwards, participants of the Long-Term Incentive Plan are entitled to dividends during the vesting period. Following a review of the accounting policies for share-based payments in 2006, the restricted shares granted in 2006 under the Annual Bonus Share Matching Plan are valued using the share price at the date of grant discounted by the dividend yield (3.66%) to take into account any dividends foregone. The fair value of shares granted under the Long-Term Incentive Plan that vest unconditionally was determined using the share price at the date of grant. The number of shares to vest was adjusted based on historical experience to account for any potential forfeitures. Restricted shares with a market performance condition were valued by an independent actuary using a Monte Carlo model. Restricted shares with a non-market performance condition were fair valued based on the share price at the date of grant. Non-market performance conditions were considered by adjusting the number of shares expected to vest based on the most likely outcome of the relevant performance criteria.

Subsidiary share option plans

IDC, a 62% subsidiary of the Group, operates the following share-based payment plans:

2001 Employee Stock Purchase Plan In 2001, IDC adopted the 2001 Employee Stock Purchase Plan for all eligible employees worldwide. The 2001 Employee Stock Purchase Plan allows employees to purchase stock at a discounted price at specific times.

2000 Long-Term Incentive Plan Under this plan, the Compensation Committee of the Board of Directors can grant share-based awards representing up to 20% of the total number of shares of common stock outstanding at the date of grant. The plan provides for the discretionary issuance of share-based awards to directors, officers and employees of IDC, as well as persons who provide consulting or other services to IDC. The exercise price for all options granted to date has been equal to the market price of the underlying shares at the date of grant. Options expire ten years from the date of grant and generally vest over a three to four year period without any performance criteria attached.

In addition, grants of restricted stock can be made to certain executives and members of the Board of Directors of IDC. The awarded shares are available for distribution, at no cost, at the end of a three-year vesting period. No performance criteria are attached to shares granted under this plan.

The number and weighted average exercise prices of share options granted under the 2000 Long-Term Incentive Plan are as follows:

The number and weighted average exercise prices of share options granted under the 2000 Long-Term Incentive Plan are as follows:

	2006 Number of share options 000s	2006 Weighted average exercise price $	2006 Weighted average exercise price £	2005 Number of share options 000s	2005 Weighted average exercise price $	2005 Weighted average exercise price £
Outstanding at beginning of year	10,068	15.16	8.37	9,832	13.46	7.36
Granted during the year	1,835	20.58	10.52	1,940	21.38	11.80
Exercised during the year	(1,252)	12.88	6.58	(1,412)	11.57	6.39
Forfeited during the year	(139)	19.02	9.72	(292)	16.86	9.31
Expired during the year	(6)	11.46	5.86	–	–	–
Outstanding at end of year	10,506	16.33	8.34	10,068	15.16	8.37
Options exercisable at end of year	6,547	14.11	7.21	6,052	12.58	6.94

The options outstanding at the end of the year have a weighted average remaining contractual
life and exercise price as follows:

The options outstanding at the end of the year have a weighted average remaining contractual
life and exercise price as follows:

Range of exercise prices $	2006 Number of share options 000s	2006 Weighted average contractual life Years	2005 Number of share options 000s	2005 Weighted average contractual life Years
0 – 4.4	30	3.1	33	4.2
4.4 – 7.5	157	2.3	206	3.6
7.5 – 12	2,164	4.4	2,685	5.3
12 – 20	4,640	6.4	5,243	7.4
> 20	3,515	9.0	1,901	9.5
	10,506	6.8	10,068	5.4

During the year IDC granted the following shares under restricted share arrangements:

During the year IDC granted the following shares under restricted share arrangements:

	2006 Number of shares 000s	2006 Weighted average fair value $	2006 Weighted average fair value £	2005 Number of shares 000s	2005 Weighted average fair value $	2005 Weighted average fair value £
2000 Long-Term Incentive Plan	196	20.82	10.64	148	20.57	11.35
2001 Employee Stock Purchase Plan	206	3.98	2.03	178	3.68	2.03

Shares awarded under the 2000 Long-Term Incentive Plan were valued based on the share price prevailing at the date of grant. The fair value of the options granted under the Long-Term Incentive Plan and of the shares awarded under the 2001 Employee Stock Purchase Plan was estimated using a Black-Scholes model. The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:

The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:

	Long-Term Incentive Plan			Employee Stock Purchase Plan
	2006 Weighted average	2005 Weighted average		2006 Weighted average	2005 Weighted average
Fair value	$6.57	$5.56		$3.98	$3.68
Weighted average share price	$20.58	$21.38		$15.58	$15.46
Weighted average exercise price	$20.58	$21.38		$15.58	$15.46
Expected volatility	25.9%	24.50%		18.32%	20.00%
Expected life	4.7 years	4.0 years		0.5 years	0.5 years
Risk free rate	4.56% to 5.11%	3.86%		3.66% to 5.22%	2.33%
Expected dividend yield	0.0%	0.0%		0.0%	0.0%
Forfeiture rate	0.0%	0.0%		0.0%	0.0%

The expected volatility is based on the historic volatility of IDC's share price over the vesting term of the options.